Memorandum from the Financial Services
Authority (FSA) and the Financial Services Compensation Scheme
1. This is a joint Memorandum by the FSA
and the FSCS ahead of our appearance before the Committee on 11
December. The Memorandum covers:
(a) the FSA's role in the coming months in
supervising Northern Rock, working with the Bank of England and
(b) changes that have already been made to
(c) the exercises now under way, involving
the FSA, the FSCS, the Bank of England and the Treasury, to learn
lessons from recent events and to improve the regulatory and compensation
arrangements for the future; and
(d) further information about the FSCS (included
in Annex 1).
A. THE FSA'S
2. Following the announcement in October
of revised Bank of England facilities and the extension of the
Treasury guarantee to new retail deposits, the firm is operating
in the stabilisation period that extends to February 2008, and
is considering its strategic options. The Tripartite Authorities'
objectives for any sale or restructure of Northern Rock are set
out in their "Statement of Principles for Assessing Proposals",
published by the Chancellor on 19 November.
3. The Tripartite Authorities are holding
regular meetings with the Northern Rock senior management team.
The FSA continues to supervise the firm at a much increased level
of intensity. (Given current market conditions, we are monitoring
all wholesale and retail banks and deposit-taking institutions
closely). In parallel, other strands of work are being taken forward
by the Bank of England and the Treasury as appropriate.
B. CHANGES ALREADY
FSA AND THE
4. The current system for deposit protection
operates within the framework established in 2001 under the Financial
Services and Markets Act 2000 (FSMA). The FSCS covers customers
of all authorised financial services firms, including banks and
building societies, for certain regulated activities. The FSA
is responsible for setting the rules within which the FSCS operates,
including on eligibility of claims and compensation limits. The
FSCS is funded through levies on the industry and has the power
to issue levies during the financial year if a particular failure
or failures make that necessary. The FSCS service is free to consumers
at the point of use.
5. In 2005 the FSA started to review the
funding model for the compensation scheme, and on 14 November
2007 announced the changes it had decided to make. The new model,
which will come into effect in April 2008, will increase the financial
capacity of the scheme for compensation arising from deposit-takers
from £2.7 billion in perpetuity to £4.03 billion annually
and will provide consumers with added certainty that valid claims
will be paid, according to the limits placed on the amount of
compensation payable by the FSCS. It will be a more robust, resilient,
efficient and cost-effective scheme.
6. In addition to this work which had been
in train for some time, in light of recent events, on 1 October
this year the FSA increased the FSCS limit for deposits to 100%
of the first £35,000 of each depositor's savings, up from
the previous limit of £31,700. The previous limit, last confirmed
in 2005, was made up of 100% of the first £2000 and 90% of
the next £33,000 of depositors' eligible claims.
C. LEARNING LESSONS
7. We recognise the widespread public concern
caused by recent events and we are determined to learn lessons
for the future. Some of the work under this heading is for the
FSA; many workstreams involve the FSA and the FSCS working with
others, including the Bank of England and the Treasury.
8. In the FSA's view, recent events confirm
the validity of its overall philosophy of principlesand
outcomefocused regulation, which seeks to foster innovation
and competition. In particular, the FSA believes that recent events
reinforce the need to focus supervision work on the outcomes and
consequences of management actions, rather than just on a firm's
compliance with individual rules. We recognise that a successful
financial market place requires innovation and competition; overall,
this approach has served the UK economy and its financial markets
well. In turn, that means there can and will be failures. However,
in the FSA's view a principles-based regime provides the best
chance of achieving the necessary balance between the benefits
and risks of innovation. The work now under way, described below,
is designed to reduce the impact on market confidence of any future
The FSA's Internal Supervisory Review
9. The FSA's Director of Internal Audit
has now begun a review to ensure that the FSA learns the lessons
from the Northern Rock events, including for its risk-assessment
and risk-mitigation practices as a whole. The review is examining
the supervisory approach adopted for the period 1 January 2005
to 9 August 2007, looking both at Northern Rock and a small sample
of other high-impact firms, in order to provide a basis for comparison.
Where aspects of relevant regulatory practice or policy are currently
already being reviewed or revised, the review team will take account
of that work in reaching its own conclusions. The FSA will publish
the conclusions of the review in March, following discussion by
the February Board. The Terms of Reference for the Review is attached
as Annex 2.
The FSA's Liquidity Supervisory Review (national
10. The Northern Rock case has also raised
questions about the authorities' approach to monitoring banks'
liquidity. The FSA and the Bank of England recognise the need
to accelerate the work already in progress on modernising the
liquidity regime, both domestically and internationally. The FSA
will therefore publish a Discussion Paper on liquidity in December.
The Paper will assess the effectiveness of the existing FSA liquidity
regimes in the light of recent events and will consider the need
for change. The Paper will build on UK work begun in early 2007
in discussion with other regulators, under the aegis of the Basel
Committee. The FSA will consult publicly for three months and
plans to publish a consultation paper with firm proposals in mid-2008.
Tripartite and FSCS work on Banking and Compensation
11. Recent events have also raised questions
about the adequacy and effectiveness of current arrangements for
dealing with banks in distress. In October the Tripartite Authorities
set out the main issues in a joint Discussion Paper "Banking
reformprotecting depositors". We have now drawn together
a number of existing and planned projects to ensure that the framework
for dealing with banks in distress, including the framework for
compensation work well to protect the interests of depositors
and help promote the stability of the financial system.
12. The diagram below shows the work that
is now under way, summarising the objectives of each workstream:
13. The banking reform project, led by the
Tripartite authorities, and working with the FSCS and others,
is reviewing the tools available when a bank is in distress, consistent
with the aims of providing appropriate consumer protection, whilst
maintaining financial stability and ensuring there is an appropriate
sharing of costs, with the taxpayer interest protected.
14. Work is being taken forward in several
areas, each led by the most relevant Tripartite Authority:
(a) identifying the areas where we would
want to ensure that continuity of banking services is provided;
(b) the way the authorities might approach
the resolution of a failing or a failed bank, and the powers which
the authorities would need to achieve this; and
(c) changes that are needed to the compensation
framework to ensure that the FSCS can safeguard depositors of
15. In addition, the FSA is pulling together,
and in some cases bringing forward, a number of existing or planned
FSA workstreams in relation to compensation provision for all
UK consumers of financial services. The objectives for this work
include: a compensation environment that offers sufficient protection
to retail customers; stakeholder confidence in the retail market
is maintained; levies raised should be sufficient to meet payments
and can be paid in a timely manner; and the scope of the compensation
scheme reflects the risks attached to those activities and is
in line with EU requirements.
16. There are two main workstreams under
(a) Scope, Limits and Operation will look
at the scope of the FSCS and at the limits payable for claims
from each sector. We have decided to bring this work forward from
(b) Long-term Tariff Reform will review tariff
measures still outstanding from the recent FSCS Funding Review,
with the aim of designing tariff levels that better reflect the
size and amount of business each firm undertakes.
D. THE OPERATION
17. Since 2001 when it was established,
the FSCS has paid about £1 billion in compensation to consumers,
including more than £560 million in payments to customers
of failed insurance companies. It has handled the failure of firms
as diverse as independent financial advisors and credit unions
through to insurance providers such as Independent Insurance.
Further information is provided in Annex 1.
4 December 2007