Introduction: the compensation schemes
Depositor and Investor Compensation Schemes have been introduced as a means of safeguarding depositors and investors from the losses that might be incurred if a credit institution or an investment firm is unable to fulfil its obligations and repay money owed to or belonging to its clients upon demand.
The Deposit Guarantee Scheme and the Investor Compensation Scheme have been in introduced in Malta in 2003 in order to transpose the respective EU Directives by way of preparation for Malta’s accession in the EU.
Both the Depositor and Investor Compensation Schemes will be outlined, however, Investor Compensation Schemes will be delved into in more detail.
The Malta Depositor Compensation Schemes
The Maltese Depositor Compensation Scheme Regulations[1] effectively transpose the Deposit Guarantee Scheme Directive (DGSD)[2] as further amended by the Amending Directive of 2009[3].
The Deposit Guarantee Scheme is essentially a mechanism which entitles depositors to claim compensation in the event that the bank fails to meet its obligations or has suspended payment.
The banking sector in Malta has emerged relatively unscathed from the financial crisis. According to the MFSA Annual Report 2009, the banking sector in Malta ‘remained resilient particularly due to the strong capital base and liquidity of Maltese banks which continued to enjoy strong positive deposit to loan ratios.’ The Maltese credit institutions have proved to be financially sound nevertheless the Depositor Compensation Scheme serves as an added layer of protection for depositors in the event of a bank failure.
The Depositor Compensation Scheme is a body corporate having a distinct legal personality which is managed by a single Management Committee appointed by the MFSA. The main functions of the Scheme include maintaining funds out of which payments are to be made to the depositors and to process claims for compensation by depositors as ‘expeditiously as possible.[4].
All credit institutions that are licensed in Malta and which accept deposits from depositors must contribute to the Scheme. [5] Protection is afforded to all those depositors who have entrusted a deposit to a credit institution in the currency of any State that is a Member of the European Economic Area.
The cost of financing the Scheme is principally borne by the participant credit institutions. The term ‘credit institution’ includes banks as well as e-money institutions. The Scheme collects funds regularly from its participants in order to build up a reserve that can be utilized immediately in the case that a credit institution fails.
Participants are required to make an Initial Contribution and pay Supplementary Contributions that are levied on a continuous and regular basis. These Supplementary Contributions are to be contributed proportionately in accordance to the percentage of eligible deposits held by credit institutions.[6] ‘Eligible deposits’ refer to the credit institution’s aggregate liability towards its depositors including any interest or premium accrued in an account or accounts held in Malta in or in a branch of a licensed credit institution.[7] The contributions of the participants to the Scheme are not refundable.[8]
The Deposit Guarantee Scheme Directive (DGSD) only provides for a minimum level of harmonization and thus some Member States may offer a higher level of protection than others. The Maltese legislator opted for an increased level of protection by introducing the requirement that every credit institution licensed to operate in Malta is to maintain a Deposit Guarantee Scheme Reserve.
The quantum of the Reserve may not be less than the amount of the eligible deposits held at the end of the year immediately preceding the year of assessment, multiplied at the percentage rate of 0.67%.[9] The assets making up the Reserve must adhere to the set of parameters set out at law in order to ensure that the assets are maintained in a diversified and liquid state.
The maximum total amount of compensation that may be paid out to a depositor is that of 100,000 euro or its equivalent in any designated currency.[10] A depositor may only submit one claim in respect of all his deposits placed with the failing credit institution and may not claim against more than one scheme in respect of a single claim.[11]
The MFSA is bound to verify and determine whether a credit institution is unable to meet its obligations and has no early or foreseeable prospect of being able to do so or has otherwise suspended payment, not later than five working days after first becoming satisfied that a credit institution has failed to repay deposits which are due and payable.[12]
The Management Committee is to proceed to pay compensation for verified claims within twenty working days of the date of the determination given by the MFSA.[13]
Only persons falling within the definition of ‘depositor' may make a claim against the Scheme. The Regulations do not cover deposits made by persons carrying on investment services, financial institutions, insurance undertakings, governmental authorities, collective investment schemes, pension funds, large companies, and same group companies amongst others. Persons directing, managing or auditing the troubled credit institution, and certain shareholders, as well as the close relatives of such persons are also excluded from the protection afforded by the Depositor Compensation Scheme Regulations.
The Malta Investor Compensation Schemes
The Investor Compensation Scheme Directive (ICSD)[14] warrants legislative intervention on the basis of the following premise: “no system of supervision can provide complete protection… [and] it is therefore essential that each Member State should have an investor compensation scheme that guarantees a harmonized minimum level of compensation at least to the smaller investor in the event of an investment firm being unable to meet its obligations.”[15] The EU legislator took into consideration the fact that an investor is not generally in a position to make a comprehensive assessment of the risks affecting a licensed investment firm.
The Investor Compensation Scheme Regulations[16] have introduced the Investor Compensation Scheme as a rescue fund for investors of investment firms which are licensed by MFSA and which have become insolvent and thus unable to return money invested by them on behalf of their clients. The Regulations transpose the Investor Compensation Scheme Directive which was first adopted in 1997.
The Investor Compensation Scheme Regulations and the Depositor Compensation Scheme Regulations generally run along the same lines. Both Schemes are set up in the form of a body corporate having a separate legal personality with the ability to invest and borrow as is deemed necessary and are both managed by the Management Committee. The Management Committee is appointed by MFSA. This Committee is made up of representatives of the MFSA, the Central Bank of Malta, licensed firms, credit institutions and customers.
The Investor Compensation Scheme Regulations, however, restrict the borrowing powers of the Management Committee of an Investor Compensation Scheme which may only take out insurance policies or incur indebtedness which does not exceed 30 per cent of the net asset value of the Scheme.[17]
Investors Entitled to Compensation
The Investor Compensation Scheme Regulations grant the right to claim compensation under the Scheme to any investor “who has entrusted money or instruments to a licence holder in connection with licensed business.”[18] The Scheme provides for the payment of compensation in respect of claims arising out of a participant’s inability to:
a) repay money owed to or belonging to investors and held on their behalf in connection with licensed business; or
b) return to investors any instruments belonging to them and held, administered or managed on their behalf in connection with licensed business or, where this is not possible, their monetary equivalent or value.[19]
The list of investors which are excluded from claiming compensation as provided by the Investor Compensation Scheme Regulations is analogous to that provided by the Depositor Compensation Scheme Regulations, thus including amongst others, professional and institutional investors, investment firms, credit institutions, financial institutions, insurance undertakings, collective investment schemes and pension funds. A noteworthy difference between the two Regulations is that in the Investor Compensation Scheme Regulations, the Management Committee of the Investor Compensation Scheme is allowed to exclude “other categories of professional and institutional investors” as it deems fit.[20]
Claims for Compensation
The Fund covers 90% of a firm’s net liability to an investor in respect of investments which qualify for compensation under the Investment Services Act subject to a maximum payment to any one person of €20,000. [21]
Cover is made available on the basis of the depositor rather than on the basis of the number of deposits, meaning that if an individual has multiple accounts he will only be covered as to €20,000 on the global amount. Any other amount exceeding such threshold is not protected and will thus have to be borne by the investor.
Compensation which has already been paid in the following forms is deducted from the amounts payable under the Scheme:
- payments received from investment compensation schemes elsewhere;
- payments from any insurance policy taken out by the claimant in respect of the investment;
- payments from the liquidator or receiver; and
- any amounts which had a right of set‐off at the date of declaration.[22]
The initial step which starts the ball rolling for a claim for compensation to be processed is the Court’s decision to put the investment firm into liquidation or the MFSA’s declaration that an investment firm has been unable to meet its obligations arising from claims by its investors for reasons which are directly related to its financial circumstances and has no current prospect of being able to do so.[23]
The Investor Compensation Scheme Regulations unlike the Depositor Compensation Scheme Regulations do not impose a time limit within which the competent authority should make a determination that a participant is unable to meet its obligations towards its investors. Under Maltese law, such a determination must be made “as soon as practicable” in line with the Directive which does not impose a time limit.
The Management Committee has the duty to notify the public by means of a notice in at least two local newspapers, of any determination of the MFSA regarding the ability of a licensed investment firm to meet its obligations to investors. The Management Committee is bound to proceed to pay compensation for verified claims within three months of the date of the determination given by the MFSA.[24]
The time-frame of three months within which payment of a claim needs to be made pursuant to a determination starts running from the determination that the investment firm is in a precarious situation as opposed to the determination of the quantum of the claim thus the Regulations aim to provide for a shorter time frame than that envisaged by the Investor Compensation Scheme Directive whereby the time limit starts to run from the determination of the quantum of the claim.
Contributions to the Scheme
The Investor Compensation Scheme is not funded by the Government or by the taxpayer; it is funded by the prescribed categories of investment firms as laid down in the Regulations. The underlying principle is that an investment firm which fails would have already contributed to the cost of its own failure.
All investment firms possessing a Category 2 or Category 3 license in terms of the Rules issued by the MFSA under the Investment Services Act are bound to make contributions to the Scheme as licence holders within these categories are authorised to hold or control clients’ Money or assets. Category 1 and Category 4 license holders are exempt from such requirement.
Category 1 investment firms cannot hold any client monies or other assets thus there are no investors which are entitled to compensation within the scope of the Regulations as the definition of ‘investor’ requires that money or instruments are entrusted to a licence holder by an investor.
By way of example, a Category 1 investment firm whose sole activity consists in the giving of investment advice is not required to make any contributions to the Scheme. This means that victims of bad investment advice can have recourse to available legal remedies including the award of damages but are not entitled to any benefits from the compensation scheme in case the investment advisor is insolvent.
If an investor makes use of the services of a broker who receives the order of the client and transmits it to the liquidity provider for execution and the third party liquidity provider goes bust, the investor may not recover by way of compensation from the Scheme as the relationship of the investor is with the broker, a category 1 investment service provider.
Category 4 investment firms i.e. licence holders authorised to act as trustees or custodians of Collective Investment Schemes are also not bound to become participants in the Scheme as collective investment schemes are expressly excluded from the remit of protection of the Regulations.
A branch of a licence holder which is licensed in a non-EEA state and operating in Malta is bound to participate in and contribute to the Scheme unless there is an agreement in force between the Investor Compensation Scheme established in Malta and the authority responsible for the management and administration of the scheme in the non-EEA state stipulating that the level or scope of cover provided for investors in that state is equal or exceeds the level or scope of cover in Malta.
A branch of a licence holder licensed in an EEA and operating in Malta is not bound to be a participant in the Scheme but may participate in and contribute to the Scheme to supplement the cover available in their home country in respect of investments made by their Malta offices if the Scheme in Malta exceeds the level or scope of cover provided in the EEA state in which it is licensed.[25]
Licence holders are to retain a minimum amount of EUR698.81 in a reserve referred to as the "Investor Compensation Scheme Reserve” in order that the funds are readily available within 30 days from the time when the Scheme makes a call on such funds. The funds held on reserve are to be invested with a third party approved in writing by the Management Committee who is to hold the funds on pledge in favour of the Scheme.
Licence holders are required to contribute to their Investor Compensation Scheme Reserve on an annual basis and are only to stop contributing once the aggregate fixed contributions paid to the Scheme and accumulated reserves held by license holders by way of the Variable Contribution amount to €2,329,373.40.
Participants are to contribute an annual Fixed Contribution as well as an annual Variable Contribution. As relates to the Fixed Contribution, this is to the tune of €2,911.72 in the case of Category 2 and €17,470.30 in the case of Category 3 investment firms.
The Variable Contribution is calculated by applying the percentage rate of 0.1% to the total revenue of the participant on an annual basis. The total revenue is defined as all gross income - whether received or receivable - from the license holder’s business activities which are licensable under the Investment Services Act, whether actually licensed or not. In the case that in any particular year, the funds already pertaining to the Reserve exceed the figure obtained through the computation of the formula mentioned above, there can be no reversal of funds. This ensures that the higher amount is always held in the Reserve.
The Malta Compensation Schemes: Concluding Remarks
The rationale behind compensation schemes is to ensure a high level of investor protection and boost consumer confidence in the financial services industry. Compensation schemes are intended to guard against the failure and insolvency of individual institutions which may give rise to a negative domino effect potentially affecting otherwise prudent institutions. Besides minimizing systemic risk, compensation schemes have also the beneficial effect of reducing to a certain degree the incentive to withdraw one’s money once a financial institution is believed to be going through tough times; depositor or investor panic is not exacerbated and a credit institution or an investment firm may be given more time to recover. The costs incurred from massive withdrawals are deemed to largely exceed the cost of credit institutions and investment firms in compensation schemes.
The Deposit Compensation Scheme and the Investor Compensation Scheme as introduced in the Maltese legal system provide an additional layer of security within an already robust regulatory and legal framework.
[1][1] S.L. 371.09
[2] Directive 94/19/EEC of the European Parliament and of the Council of 3 March 1997 on investor-compensation schemes, Official Journal L 084, P. 0022 – 0031, Brussels, 1997.
[3] Directive 2009/14/EC of the European Parliament and of the Council of 11 March 2009 on deposit-guarantee schemes as regards the coverage level and the payout delay, Official Journal L 68, Brussels, 2009,
[4] Art.4, Depositor Compensation Scheme Regulations
[5] Ibid Art.11
[6] The amount of Supplementary Contributions to be paid is the resulting amount after multiplying the amount of the eligible deposits of that participant as at the end of the year immediately preceding the year of assessment with the percentage rate of 0.1%.
[7] Ibid. Art.18(1)
[8] Ibid. Art.12(1)
[9] Ibid. Second Schedule, Art.5
[10] Ibid. Art.17(1)
[11] Ibid. Art.20
[12] Ibid. Art.13(1)
[13] Ibid. Art.14(4)
[14]Directive 97/9/EC of the European Parliament and of the Council of 3 March 1997 on investor-compensation schemes, Official Journal L 084, P. 0022 – 0031, Brussels, 1997
[15] Ibid. Recitals 3 and 4
[16] S.L. 370.9
