Standard Life ezine - FSCS - the fund of last resort or the only resort? – Standard Life Savings & Investment Ezine

Standard Life's Savings & Investment newsletter for advisers

Issue 8: November 2007

Planholder and investor financial protection has been brought into focus in the weeks and months following the problems encountered by Northern Rock customers. Even the Pre-Budget Report has failed to detract from the issue.

Sales Technical Services regularly receives calls asking for clarification about what protection Standard Life customers would get if an authorised firm went out of business. We have therefore produced the following brief overview.

The starting point is the Financial Services Compensation Scheme (FSCS). The FSCS was introduced at the same time as the Financial Services and Markets Act 2000 and will pay compensation to eligible claimants when an authorised company can’t (or probably can’t) pay claims against it and where a client suffers loss due to mis-selling, negligence or the firm defaulting. The FSCS has maximum payouts which are:

Deposits – cover up to £35,000;
Life Insurance plans – Covers long-term plans up to 100% of the first £2,000 followed by 90% of the balance;
Investment business – Cover up to £48,000 (100% of the first £30,000 and 90% of the next £20,000);
Mortgages - same as investment business for mortgages arranged on or after 31 October 2004.

Planholders who invest in Standard Life insured funds through ‘tax wrappers’ such as a Standard Life personal pension plan or life investment bond are protected through the long term assurance part of the FSCS (see above).

Where the client wants to invest in a wider range of funds external to Standard Life then the FSCS protection may not apply. This is because it is one of the Standard Life group of companies which has bought the external investment, not the client. However, although an authorised firm might go out of business, the money it has invested on behalf of a client is looked after by a custodian whose duties include making sure the money invested is kept separate from the firm’s own assets and liabilities. If we look at an example we should be able to see how this works in practice:–

Example
Mr Smith invests £100,000 into a Standard Life SIPP. Part of the underlying investment portfolio includes investment in mutual funds and he puts £10,000 into Invezt-it Emerging Markets Fund, a high-volatility unit trust fund. Three years later Invezt-it goes out of business. What has happened to Mr Smith’s £10,000?

The investment is owned by Standard Life Trustee Company Limited (SLTC, the trustees of the Standard Life SIPP). SLTC have rights to the surrender value of the current value of units within the unit trust. They should apply for the surrender value of the units. When they do, here are two possible outcomes:-

Although Invezt-it (as a company) has failed, the Emerging Markets Fund has still performed well. The fund’s custodian ensures that the fund assets are kept separate from the company’s liabilities so are safe from creditors. On surrender, SLTC (and therefore the SIPP client) gets a good return from the fund.

News spreads that Invezt-it is in trouble. Investors start cashing in from all Invezt-it’s funds and the unit prices fall heavily as the fund managers try to protect the funds. When SLTC applies for the surrender of the units they only receive £5,750. The loss is unfortunately just a poor investment return and neither SLTC nor Mr Smith could claim from the FSCS.

Summary
There can be several companies in the chain when a client invests through a ‘tax wrapper’ (such as a SIPP or an investment bond). These can start with the financial adviser and go all the way through to an external fund manager. In cases such as this, it is important to note that the client’s money is not lost just because one of the companies in the chain collapses. What the client will actually get back from their investment will depend on factors such as market conditions, a potential run on the fund due to loss of investor confidence, whether they were mis-sold the contract and/or whether there was any negligence on the part of the fund manager(s).

Examples of when the FSCS would get involved
In the above example, it’s probably going to be limited to cases of negligence or mis-selling. For example – if the Emerging Markets Fund literature had wrongly described the fund as a moderate risk or if Mr Smith was a ‘risk-averse’ client but was still advised to invest in the fund anyway. Also, if Invezt-it’s fund managers recklessly invested in a very narrow range of investments and made no attempt at diversification, it could be regarded as negligence on the part of the fund manager if the fund imploded.

In these cases it may be possible to claim compensation, but only if the firm which caused the loss is in default (i.e. insolvent and unable to pay its liabilities). The next question would be – who can actually make the claim? If Mr Smith had bought the unit trust directly from the fund manager he would be able to make the claim, but this would be through the “investment business” part of the FSCS.

However, if (as in this example) the SIPP trustees bought the unit trust it is they who might be able to make a claim. Note - the FSCS rules cover individuals and certain small companies or small trusts – the FSCS rules does provide cover for trustees of some pension schemes (e.g. SIPP trustees) but not for others (e.g. most occupational scheme trustees are ineligible).

Offshore deposit accounts for International Bond
There have been a lot of questions surrounding this. Basically there’s good news, bad news and realistic views!

First the bad news. In the FSCS guide, it states ‘Deposit takers in the Channel Islands and the Isle of Man are not covered by the scheme’. Banks based in the Isle of Man have their own compensation scheme and Jersey and Guernsey do not currently have their own compensation schemes. However, both regulatory bodies are reviewing the situation. This effectively means that offshore deposit accounts available through the International bond are not covered by the scheme.

Now the good news. Each of the jurisdictions where the deposit takers for the International Bond funds are based have regulatory authorities – Jersey Financial Services Commission, Guernsey Financial Services Commission and Isle of Man Supervision Commission. In addition, any money invested by Standard Life International Limited (SLIL) on behalf of International Bond clients is covered by the same custodian structure, thereby keeping these assets separate from SLIL’s assets.

The realistic view. When considering which offshore deposit funds should be made available within the International Bond, SLIL carried out robust due diligence on each deposit taker. They all have very strong parent companies in the Republic of Ireland or the United Kingdom with excellent Moody’s, S&P and/or Fitch ratings.

FSCS confirms new model from 2008
The Financial Services Authority (FSA) has recently confirmed the future funding arrangements for the FSCS which will operate from 1 April 2008. More information can be found on the FSA website.

The link provided is for general information purposes only. Standard Life accepts no responsibility for information contained in the site or for the site not being available at all times. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.