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Starting this week, the European Commission will begin evaluating whether the Investor Compensation Schemes Directive (Directive 1997/9/EC) is doing enough to protect investors against the risk of losses in the event of an investment firm's inability to repay money or return assets held on behalf of their clients.
The main purpose of the directive is to protect investors' money and financial instruments in the case where insolvency or default make it impossible for an investment firm to return them to (essentially retail) investors.
The law is intended to better protect investors' assets against the risk of fraudulent misappropriation. It may also provide protection in cases where the loss of investor assets in the event of a firm's default derived from errors, negligence or problems in the firm's systems and controls.
The commission will look at evidence relating to the scope of the directive and its implementation to date, as well as the crucial aspect of how the compensation schemes get funded.
The Investor Compensation Schemes Directive was modeled on the Deposit Guarantee Schemes Directive (1994/19/EC) which set minimum rules for compensation of customers of credit institutions (such as banks) that fail. The directive is analogous to the Federal Deposit Insurance Corporation structure in the US.
The purpose of the Directive on Deposit Guarantee Schemes is to protect depositors' savings and to ensure confidence in the banking sector, so as to avoid Depression-style bank runs with their severe economic consequences.
That directive has remained unchanged since 1994 but is now being updated to respond to the ongoing financial crisis. Under the new Directive on Deposit Guarantee Schemes rules, the minimum level of coverage for deposits was increased from â‚¬20,000 (as of October 2008) to â‚¬100,000 (as of October 2009).
In addition, member states must ensure, under the new rules, that the deposit is reimbursed up to the coverage level, while under the old directive member states had the option to decide that a deposit guarantee would only cover 90% of savings.
Furthermore, under the new rules the time allowed for the deposit guarantee scheme to pay depositors in the event that a bank fails was reduced to three days.
Before that the period was three months, and could even be extended to nine months.
The writer is the head of the International Department at GSCB Law Firm