Fixing the CSLR: the UK FSCS offers lessons - but not a blueprint

Having recently returned from the UK, I could not help but notice the stark contrast in one important area of financial services policy.

This week, industry bodies and government representatives are expected to sit down to discuss the escalating costs associated with Australia's Compensation Scheme of Last Resort (CSLR). At the same time, the UK's equivalent scheme - the Financial Services Compensation Scheme (FSCS) - is reportedly forecasting lower-than-expected costs.

How can two systems designed around broadly similar principles produce such different outcomes? More importantly, what practical lessons can Australia take from the UK experience as policymakers consider how to stabilise and improve the CSLR?

In the UK, the FSCS is rarely front-page industry news. It exists, it matters, and it occasionally attracts debate, but it is broadly viewed as a mature and accepted part of the financial system's infrastructure.

In Australia, the CSLR feels very different.

Almost immediately after returning home, I was struck by the tone of the discussion: soaring levy forecasts, warnings from industry bodies that the model may be unsustainable, advisers openly questioning the fairness of the scheme, and policymakers reviewing a framework that appears to be under pressure almost as soon as it has been introduced.

What makes the contrast even more striking is the timing.

Just as the Australian industry was digesting another wave of escalating CSLR forecasts, reports emerged in the UK suggesting the expected FSCS levy may actually come in lower than forecast. That does not mean the FSCS is perfect - far from it - but it does suggest a system operating with a degree of stability and predictability that Australia's CSLR currently lacks.

The comparison is useful not because Australia should try to replicate the UK model wholesale, but because it highlights the importance of designing compensation frameworks that reflect the structure, scale and economics of the market they operate within.

That is where Australia's CSLR increasingly appears to face challenges.

The Critical Difference: The UK Built a System Around Scale

The UK's FSCS exists within one of the world's largest financial services markets.

It sits atop:

• Major global banking institutions
• Large insurance markets
• Deep capital markets
• Strong prudential regulation
• A broad levy base
• Significant institutional participation

Most importantly, the cost of the system is spread across an enormous financial ecosystem.

Australia's CSLR, by contrast, sits predominantly, on top of a comparatively small - and shrinking - financial advice profession.

That difference is not cosmetic. It is structural.

Australia now has only around 15,000-16,000 financial advisers remaining after years of post-Royal Commission reform and industry attrition. Yet the sector is increasingly being asked to absorb compensation liabilities associated with large historical failures and investment collapses.

This creates a very different risk dynamic from the UK.

A levy that is manageable when spread across a vast institutional market becomes far more difficult when concentrated on a relatively small professional cohort.

That appears to be one of the key pressures emerging within the Australian model.

The CSLR Is Becoming Concentrated Around Historic Advice Failures

One of the most important realities in the current debate is that the CSLR is not operating as a broad-based systemic protection scheme in the way many consumers might assume.

Instead, it is becoming heavily concentrated around major advice and investment failures linked to firms such as:

• Dixon Advisory
• United Global Capital
• First Guardian Master Fund
• Shield Master Fund

This concentration matters because it changes the economic profile of the scheme.

The original policy rationale for the CSLR was straightforward: consumers should not be left uncompensated when financial firms fail, or fail to pay AFCA determinations.

That principle is difficult to dispute.

However, the emerging reality is more complicated. A relatively small number of advisers and firms are increasingly being asked to collectively fund the consequences of major historical collapses - many of which were linked to business models, regulatory settings and institutional behaviours that no longer exist in the same form today.

One unintended consequence is that rising costs may ultimately reduce the availability of affordable financial advice for ordinary Australians.

Australia Risks Creating a Negative Feedback Loop

The challenge is not simply that levies increase.

The concern is the feedback loop the CSLR may unintentionally create.

The sequence looks something like this:

1. Large compensation liabilities emerge.

2. Levies on advisers rise sharply.

3. Compliance and operating costs increase further.

4. More advisers leave the industry.

5. The funding base shrinks.

6. Remaining participants carry even larger costs.

7. Fewer advisers means fewer Australians receiving professional advice.

At some point, the economics become increasingly difficult to sustain.

This is one of the clearest differences between Australia and the UK.

The FSCS benefits from scale. The CSLR currently operates within a much narrower funding base.

The UK system can absorb volatility more easily because the levy burden is distributed across a far broader and deeper financial system. Australia's advice market is simply more concentrated, making it more vulnerable to large compensation events.

The Foregone Gains Issue Deserves Closer Attention

Another issue attracting increasing concern is the inclusion of "foregone gains" in some compensation outcomes.

This may sound technical, but it goes to the heart of what the CSLR is intended to achieve.

Traditional compensation schemes are generally designed to protect consumers from:

• Fraud
• Insolvency
• Misconduct
• Failure to return client assets

What they are not usually designed to do is compensate investors for hypothetical returns they might have earned elsewhere.

Once compensation frameworks begin incorporating foregone or hypothetical gains, the liability profile changes significantly.

The scheme starts moving away from consumer protection and closer toward investment outcome insurance.

That distinction matters because it potentially creates:

• Open-ended liabilities
• Greater claim volatility
• Moral hazard concerns
• Significant uncertainty for firms funding the scheme

This issue deserves far more public attention as the CSLR review progresses.

The UK Experience Still Offers Valuable Lessons

None of this means Australia should abandon consumer protection mechanisms.

Nor does it mean the UK system is perfect.

In reality, the FSCS itself has faced criticism over the years, particularly following periods of financial crisis and major firm failures.

But the UK does offer several useful lessons that could help inform Australia's review of the CSLR.

1. Compensation schemes work better when the funding base is broad

The wider the risk pool, the more manageable the system becomes.

Australia may ultimately need to reconsider whether a relatively small advice profession can sustainably carry such a large proportion of compensation costs.

2. Strong prudential settings matter more than compensation after the event

Preventing failures is far cheaper than compensating for them later.

The UK system sits within a mature prudential framework with stronger institutional oversight and larger capital buffers than much of Australia's historical advice sector operated under.

3. Stability and predictability matter

Constantly escalating levy forecasts undermine confidence in the system itself.

One reason the FSCS attracts less controversy today is not because nobody pays for it - they do - but because the market largely understands the rules, the risks and the likely cost profile.

Australia has not yet reached that point.

4. Compensation frameworks need to reflect local market realities

This may be the most important lesson of all.

Financial systems differ significantly in:

• Market size
• Industry structure
• Institutional concentration
• Adviser economics
• Consumer behaviour

Compensation schemes inevitably operate differently depending on those conditions.

The challenge for Australia is not to mirror another country's system, but to design a model that is sustainable within the realities of the Australian market.

The CSLR Does Need Reform - But Reform Should Be Careful

There is now a growing consensus across parts of the industry that the CSLR requires adjustment.

Possible reforms could include:

• Narrowing eligible claims
• Reconsidering compensation for foregone gains
• Strengthening capital requirements for licensees
• Improving professional indemnity settings
• Broadening the funding base
• Tightening AFCA methodologies

But policymakers should also avoid overcorrecting.

Consumer trust matters. Confidence in financial services matters. Australians should have access to meaningful protection when misconduct occurs.

The challenge is finding a model that protects consumers without destabilising the very profession expected to fund it.

That balance has not yet been achieved.

Australia Should Learn From the UK - While Designing for Australia

The UK's FSCS offers useful lessons for Australia, but it does not provide a direct blueprint.

The institutional conditions supporting the FSCS took decades to evolve and exist within a vastly larger financial ecosystem.

Australia's challenge is therefore not to replicate the UK system, but to apply the underlying lessons in a way that reflects local conditions.

The CSLR debate is ultimately becoming about something larger than compensation policy alone.

It is becoming a test of whether Australia can design a consumer protection framework that is both fair and financially sustainable over the long term.

The UK experience suggests that stability, scale, predictability and strong prudential settings all matter.

The task now is determining how those lessons can be adapted to work effectively within the realities of the Australian market.