Quelle: EU MEMO/10/319, Brussels, 12 July 2010 (auf www.europa.eu, August 2010)
1) What are Investor Compensation Schemes?
Investor Compensation Schemes protect investors using investment services by providing compensation in cases where an investment firm is unable to return assets belonging to an investor. This might occur for example where there is fraud or negligence at a firm or where there are errors or problems in the firm’s systems. It does not cover investment risk: for example, when an investor has bought stocks which then fall in value. In the EU, Investor Compensation Schemes are covered under a Directive dating back to 1997 (97/9/EC). Investor compensation schemes are a last resort safety net.
2) Why is the Commission proposing a review of Investor Compensation Schemes?
This initiative is part of a broader package on compensation and guarantee schemes that comprises the proposal for amendment of the Directive on Deposit Guarantee Schemes (DGSD) and a White Paper on the insurance schemes. Overall, the package represents a fundamental step towards restoring consumer confidence in financial markets.
The review is in line with the Commission Communication of 4 March 2009 „Driving European recovery“, the more recent Commission Communication of 2 June 2010 on „Regulating Financial Services for Sustainable Growth“ and G20 objectives which underline the need to address any regulatory loopholes in the regulatory and supervisory system, to reinforce the protection of consumers, investors and small businesses in order to favour their access to capital markets and to restore their confidence in the financial system.
The Investor Compensation Schemes Directive (ICSD) was adopted in 1997 and provides for clients receiving investment services from investment firms to be compensated in specific circumstances where the firm is unable to return money or financial instruments that it holds on the client’s behalf.
Ten years after the ICSD entered into force, and in the context of the financial crisis, it is necessary to revise the functioning of the ICSD in order to ensure that it continues supporting its overarching objectives – to protect investors and to assist the proper functioning of the single market for investment services.
A number of frauds in Member States have resulted in important losses to small investors and the functioning of the schemes has shown several limits, as also emerged from numerous complaints received by the Commission and relating to the lack of sufficient compensation and delays in payments by the schemes.
Moreover, the Directive needs to reflect changes in the regulatory framework and market developments since 1997. The ICSD was adopted to complement the Investment Services Directive (93/22/EEC), which has subsequently been repealed by the Market in Financial Instruments Directive (2004/39/EC), otherwise known as MiFID. The review of the ICSD thus needs to take into account the new framework established under MiFID for the provision of investment services across Europe.
The ICSD was also initially modelled on the Deposit Guarantee Schemes Directive (94/19/EC), which was revised during the crisis in order to increase its level of coverage and is being further modified in other areas. The modifications of the Deposit Guarantee Schemes Directive (DGSD) need to be reflected, where appropriate, in the framework of the ICSD.
3) What are the objectives of the proposal?
The revision aims at increasing the protection provided to investors under the Directive and strengthening confidence in the use of investment services, updating and improving the practical functioning of the schemes and keeping pace with regulatory evolution.
The main proposals, in line with the overarching objectives of the revision, are to:
- increase the level of compensation payable to investors under the Directive from a minimum of €20 000 to a fixed level of €50 000.
- remove the option under which investors could bear a proportion of up to 10% of the loss within the compensation limit.
- set out in more detail how investor compensation schemes should be funded including requiring a sufficient level of pre-funding to ensure soundly funded schemes.
- provide for greater cooperation between schemes including the possibility of a borrowing mechanism between national schemes that could operate as a last resort tool.
- reduce delays in the payout of claims to investors including provision for partial payouts to be made if claims are not settled within a specified period.
- clarify that all investment services and activities covered under MiFID should be subject to the ICSD and that if firms de facto hold client assets (irrespective of restrictions on their authorisation or the nature of their investment service) then clients should be entitled to compensation under the ICSD.
- provide that investors have the right to be compensated by the scheme also in the case of failure of a third party custodian resulting in the investment firm not being able to return the client’s assets.
- extend coverage to provide for compensation to UCITS unit holders (collective investment schemes) when there is a loss of assets due to the failure of the depositary of a UCITS scheme or a sub-custodian.
- provide for investors to receive more detailed information from firms about what is covered and not covered under compensation schemes.
4) What are the protections that investors are entitled to under the existing Directive and how is this different from the Deposit Guarantee Scheme Directive?
The Directive protects clients when they entrust money or financial instruments to an investment firm. Clients must be compensated by schemes in two situations derived from reasons directly related to the financial circumstances of the firm:
- if a firm is unable to repay money owed or belonging to a client and held on the client’s behalf in connection with investment services; or
- if a firm is unable to return to a client a financial instrument belonging to the client and held, administered or managed on the client’s behalf.
The Directive does not compensate investors for „investment risk“ (the risk that an investment will result in a loss) and operates only as a last resort safety net for clients of investment firms if other important safeguards fail.
Claims under the Directive typically arise if there is fraud or other administrative malpractice within a firm or due to inability to fulfil obligations towards clients‘ assets as a result of a firm’s errors, negligence or problems in the firm’s systems and controls.
The Deposit Guarantee Schemes Directive provides for bank account holders to be compensated up to a specified limit if the bank is not in a position to pay back the money.
5) Why is it necessary to increase the level of compensation?
When the Directive entered into force in 1997, it provided for a minimum level of compensation of € 20 000. This amount has not been amended and there are concerns that it might be too low. The compensation limit of € 20 000 was never adjusted to reflect inflation or the increased exposure of European investors to financial instruments since 1997. There are also concerns that significant discrepancies have developed between different Member States in compensation limits that could lead to investor arbitrage. So, in addition to increasing the compensation limit to € 50 000 to more accurately reflect the average value of assets held by firms for investors, the amendments will provide that this should be a harmonised rather than a minimum level.
6) Why is it considered necessary to cover third party custodians?
The Directive does not cover a potential failure of a custodian with whom an investment firm has deposited a client’s assets. So, in a case where a third party custodian is not able to return the financial instruments to the firm or the client, the client will not be able to benefit from any compensation payment under the Directive.
This creates a potentially large gap in coverage under the Directive as whether an investor is eligible for compensation may depend on whether the investor’s investments are being held by the firm or by a third party. Further, investors may not be aware of this difference under the Directive.
7) Why is it considered necessary to cover collective investment scheme depositaries and sub-custodians?
Unit holders in collective investment schemes, also known as UCITS, are currently not entitled to compensation if a depositary or sub-custodian fails to return assets. In recent cases, such as the recent Madoff case, unit holders in collective investment schemes have suffered loss due to such failures. It is therefore considered appropriate to extend the scope of coverage under the Directive to allow investors to claim in such situations.
8) Why is it necessary to set a common regulatory framework related to the funding of the schemes?
The Directive currently provides very little detail about how schemes should be funded apart from making it clear that the funding should come from market participants.
Since the Directive commenced there have been some high profile cases where, due to problems of funding, the national investor compensation scheme has had insufficient funds to pay out claims.
Sound funding arrangements are critical to the effectiveness of compensation schemes in achieving the Directive’s objectives. Funding can affect the ability of schemes to meet their obligations under the Directive, how rapidly clients can be compensated and the contributions required from firms in the event of losses.
The proposed revisions therefore provide further details about how schemes should be funded. This includes calculating a target funding level (cf question 11) and having a defined amount of pre-funding (i.e. funding in anticipation of future claims) (cf question 11).
9) Why is it considered necessary to introduce a borrowing mechanism across national schemes?
Together with the establishment of consistent funding rules between Member States, the introduction of cooperation arrangements among national schemes will provide greater protection to investors and will promote investor confidence in investment services. It will also favour the harmonisation of practices adopted by national schemes in fulfilling their obligations, thus reducing the risk of regulatory arbitrage by Member States. A borrowing mechanism among schemes is introduced as a last resort tool. The system is based on the principle of cooperation between national schemes. These measures should provide schemes with an alternative back up source of funding, under specific conditions and on a temporary basis.
More details about the borrowing mechanism are set out below:
- schemes should have the right to borrow from the other schemes if their funds are insufficient to cover their immediate needs;
- a portion of ex-ante funding in each compensation scheme will have to be available for lending to other schemes;
- the European Securities Market Authority (ESMA), one of the future European supervisory authorities, should receive any borrowing request, assess whether the relevant requirements are met and, if this is the case, transmit it to the other schemes;
- loans should be repaid to the lending schemes no later than five years after the request. Interest should accrue on the loans; the interest rate shall be equivalent to the marginal lending facility rate of the European Central Bank;
- the borrowing mechanism should be limited to the claims covered under the Directive. For instance, schemes will not be able to borrow for any needs arising from the default of entities not included in the scope of the Directive;
- to avoid the situation where the funds available for lending at EU level are rapidly exhausted, a limit of 20% of the portion set aside for lending may be used for each case.
10) Why are there proposals to introduce strict payout delays?
In the functioning of the Directive, there has been evidence of significant delays in certain situations before claims have been paid out to investors. For example, in one case payouts took almost four years. While the payment of claims under this Directive are not as urgent as payment of claims for deposits under the DGSD, significant delays can undermine investor protection and investor confidence in the use of investment services. For this reason, the proposal provides that, if final payment has not been made within nine months of the date when the firm is declared unable to meet its obligation, the investor should receive a partial compensation based on the initial assessment of the claim.
11) How are the Investor Compensation Schemes to be funded?
The target fund level should represent at least 0.5% of the value of the assets covered by the protection of the schemes. The target fund level should be financed with regular contributions from members of the schemes (such as banks, investment firms, investment funds). When funds collected in anticipation of future claims are not sufficient to meet their obligations, the schemes should make additional calls for contribution to their members. The additional contributions shall not exceed 0.5% of the assets covered by the protection of the schemes.