On 30 December 2020, Prime Minister Boris Johnson announced to the House of Commons that we had “…got Brexit done…”, and 11pm the following day marked the end of the transition period, after which the UK was no longer subject to EU law, and meant the conclusion of a lengthy negotiation of a complex trade agreement between the UK and EU.
Financial services were not addressed in detail in this agreement, which in its 1,246 pages covered many ‘big ticket’ items – most notoriously fishing – and plenty of niche areas such as the rules of origin for soap and knitted clothing. In that vein, let’s turn then, to our industry’s equivalent of the Aran sweater: the UK’s Financial Services Compensation Scheme (FSCS).
The intention is that the UK and EU will reach a ‘Memorandum of Understanding’ on financial regulation by the end of March 2021. In the meantime, however, this has led to ambiguity in certain areas, one of which is the breadth of coverage for the FSCS.
What is the FSCS?
The FSCS is designed as a ‘last resort’ compensation scheme, for scenarios where financial service firms (that are authorised by the FCA or PRA) fail and cannot settle outstanding claims themselves. It is funded by a levy on authorised firms and covers various assets such as cash deposits and investments.
Importantly, the FSCS doesn’t apply to any individual investments but to firms and cases of financial advice – so the £85,000 limit of the scheme would be per firm that failed rather than on a security-by-security basis. It’s intended to protect against institutional risk rather than market risk – so if a security plunges in value due to market factors and clients lose money this way, there is no recourse to the FSCS, as that’s part of the risk a client takes when investing. However, if a broker, provider or the firm managing a fund were to become insolvent and couldn’t settle obligations to clients themselves, that’s when there would potentially be a claim of up to £85,000 per firm.
In late 2020, there were some indications that investors in UK-managed, EEA-domiciled securities would lose the protection of the FSCS following the end of the transition period. This would have captured several high-profile and popular funds. The FCA and FSCS have recently provided some helpful clarification which should give some comfort to investors. After 31 December 2020:
- investors in UK-domiciled funds managed by UK firms are still covered by FSCS protection as before, provided the investor is eligible;
- investors in EEA-domiciled funds which have a UK branch are covered by extended FSCS protection, provided the investor is eligible – this is an extension of the coverage that was in place before; and
- investors in EEA-domiciled funds managed by EEA firms without a UK branch are not covered by FSCS protection. In this scenario, it is possible that the home state of the EEA fund will have a similar compensation scheme available, however its availability will depend on specific circumstances.
Note that, in each scenario, there are elements of individual client situations that will need to be considered to establish the full position. There are also eligibility rules, which investors must meet before being able to make a claim.
Wider investor protection
Although the FSCS is a well-known safety net for investors, it should also be noted that it is a last resort scheme. For UK-authorised firms, there are a variety of protections in place that would come into play before the FSCS, such as:
- the FCA’s Clients Assets (CASS) rules – these mandate that investment firms must keep their client and firm assets separate at all times, ensuring that if a firm were to fail, all of the outstanding claims from clients could be settled in full;
- for most funds, there is a system of separation of firm and customer assets via an independent trustee, depositary and/or custodian; and
- capital adequacy rules, which oblige firms to hold sufficient capital to cover the costs of an insolvency event.
Therefore, even if an authorised firm does fail, most clients ought to get back all their money without needing to claim via the FSCS. It may be the case that investors find the additional layers of protection more reassuring than the FSCS on its own.
As always, it is important for clients to understand the protections that are available for their investments. Following the end of the Brexit transition period, it may well be worth reviewing portfolios to establish whether coverage is as comprehensive as first thought, but investors should gain some comfort from the various protections in place and confirmation that, post-Brexit, FSCS coverage will remain in place in most instances.
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