Directive 1997/9/EC on Investor Compensation Schemes: Call for Evidence

Directive 1997/9/EC on Investor Compensation Schemes: Call for Evidence

By email:

Directorate General Internal Market and Services,

Unit G3 – Securities Markets

SPA 2 03/079,

B-1049 Brussels,


7 April 2009

Dear Sir/Madam

Directive 1997/9/EC on Investor Compensation Schemes: Call for Evidence

The IMA represents the asset management industry operating in the UK. Our members include independent fund managers, the investment arms of retail banks, life insurers and investment banks, and the managers of occupational pension schemes. They are responsible for the management of over £3 trillion of assets, which are invested on behalf of clients globally. These include authorised investment funds, institutional funds (e.g. pensions and life funds), private client accounts and a wide range of pooled investment vehicles.

We agree that a review of the ICSD is necessary, particularly in the current economic climate, and also to bring it into line with the DGSD. Effective compensation arrangements are critical for financial stability and for investor confidence, and the destabilising effect of disparities across different schemes has been clearly evidenced recently. The current status quo – where a number of MiFID investment services are currently outside the scope of ICSD – is undesirable and confusing from a consumer protection viewpoint. Retail investors should have the certainty of knowing that any MiFID investment firm they deal with is covered by a compensation scheme (or, if this is not feasible from a cost benefit point of view, any gaps in cover should be clearly disclosed).

But whilst increased cover is clearly desirable from a consumer confidence perspective, the downside is increased costs – which could be substantial, particularly if the proposals to cover third party default and losses arising from violation of conduct of business rules go ahead. This could give rise to a massive and unpredictable increase in levies for firms – which could itself have a destabilising effect on the markets – and which will ultimately have to be passed onto investors. Therefore any proposal to radically widen the scope of the Directive needs to balance the positive effect on consumer confidence against the potentially detrimental effect on the market. Following on from this, there should be clear disclosure to investors about the types of losses which are – and are not - covered.

1) Should the operation of multilateral trading facilities be excluded from the scope of the ICSD?

The operation of MTFs is within the scope of the UK Financial Services Compensation Scheme (“FSCS”) and overall we see no reason why this should not be brought within the scope of ICSD.However, as a matter of practice most transactions would be effected with professional clients and therefore would not be covered.

2) Would it be appropriate to include in the scope of the ICSD all investment firms seeking authorisation to the provision of investment services, although their authorisation would not allow holding clients' assets?

Yes (as is currently the case with FSCS). An authorised firm may control a firm which does hold client assets even though it itself does not have authorisation to do so (for example, a private client portfolio manager with a wholly-owned nominee company). Also, if the ICSD is extended to cover losses arising from violations of conduct of business rules, it would be illogical not to extend its scope to cover firms which do not hold client assets, and, again, it would be less than satisfactory from a consumer viewpoint. The majority of cases processed by the FSCS investment sub-scheme related to pensions mis-selling where consumers were advised to move out of occupational schemes into personal pensions.

3) Would it be appropriate to include in the scope of the ICSD all investment firms seeking authorisation to the provision of investment services, although they provide their services only to non-retail clients?

Under the FSCS, all firms requiring FSA authorisation have to participate in the scheme. But firms with no retail clients are exempt from compensation levies, and the FSCS tariffs are in the process of being revised so that fees will be levied in proportion to eligible business. We feel a similar approach would be best at EU level – since retail investors should have the certainty of knowing that any firm carrying on investment activities is within the scheme.

4a) Should investors be able to claim compensation in the case of default of the third party where their assets had been deposited?

4b) Should investors (such as UCITS or a UCITS unitholder) be able to claim compensation for loss of assets under the ISCD in those cases where the UCITS depositary or the institution which has been mandated to safe keep the assets, fail to perform its duty?

Extension to third party default is clearly desirable from a consumer protection and reputational point of view, but could have major cost implications for participants, and it is difficult to give a definitive answer to this in the absence of any cost benefit analysis. In the UK, as a general rule, claims will only be within scope where there is a contractual relationship between the defaulting firm and the investor – although this is generally assessed on a case by case basis.

In any event– taking into account the potential for increased costs - we feel on balance that any extension in scope would need to be limited so that claims are restricted to loss of assets/cashwhich had been deposited with the third party– as custodian/banker/ counterparty to the transaction in the course of trading, and not to losses arising from investment risk, and that claims are restricted to defaulting firms which are participants in the relevant scheme (so, for instance, in the case of the FSCS, UK authorised firms).Even so, we feel that any widening of the scheme along the lines suggested should be subjected to more rigorous cost benefit analysis.

4(b) raises the issue of whether the UCITS or the UCITS unitholder should be able to claim – if this were the case then any limits on the claim should be referenced to the claims of the individual underlying beneficial holders, rather than limited to the aggregate claim from the UCITS or nominal holder.

5) Should loss events include also any losses suffered by (retail) investors as a consequence of the violation of conduct of business rules?

We would support this where there is causal link between the rule breach and the loss.

6) Do you agree with the idea that the amount covered by the ICSD should be adapted following the updating of the DGSD?

Yes; - we feel that this is essential to maintain consumer confidence and to prevent flows of funds from investment to deposit based products – as we saw when a number of national Governments gave undertakings to guarantee bank deposits following the default of Icesave. And bringing ICSD and DGSD into line is consistent with the approach within the EU to try to ensure that there is a more level playing field for products which are economically substitutable .

7) The ICSD does not harmonize the funding systems of the schemes. Should the ICSD provide for some general principles concerning the funding of the schemes?

Although we can see the arguments in favour of this, we doubt that harmonisation of funding for the various schemes would be practical, and believe that the detail of the funding arrangements should be left to individual member states.

But it is essential that compensation schemes are run efficiently and are able to pay out valid claims as smoothly and as speedily as possible. There should be a mechanism at EU level for monitoring the performance of the schemes and, where schemes are not meeting their objectives, investigating whether this is attributable to the funding process.

8a) Does the legislation of the MemberState you know the best provide mechanisms aimed at limiting compensation schemes' obligations over time? If yes, how many clients saw their compensation unpaid as a result of such mechanisms?

8b) Should this kind of mechanism be prohibited?

This is not an issue with the FSCS, but we would strongly oppose any arrangements whereby consumers were unpaid as a result of any mechanism to limit the liability of the scheme.

9a) Should the process of recognizing the eligibility of the claim be regulated for the purposes of the ICSD?

9b) Should, at least, a mechanism be introduced providing for provisional partial compensation based on a summary assessment of clients' positions?

9c) Irrespective of the harmonisation of their funding systems, should compensation schemes ensure that they have minimum reserve funds in order to comply rapidly with any immediate needs?

These changes may be desirable in theory but any harmonisation could be constrained by the differences in insolvency law within the member states. There remains no European directive for the insolvency of investment firms, in contrast to credit institutions. We do, however, support the harmonisation of the ICSD with the DGSD as far as possible, and any mechanisms for streamlining the assessment process which can be carried across to the investment scheme would be welcomed.

10) Do you think special attention should be given to money market funds?

We would oppose the suggestion that investors in money market funds should be compensated for any investment losses.

11) Based on the concrete application of the ICSD do you see further issues other than the ones mentioned in the present document that might be of relevance to this analysis?

As noted above, clarity of disclosure to investors about the scope and level of cover is of paramount importance, particularly where there are cross-border differences.

Yours faithfully

Alwine Jones

Adviser, Regulation