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How are my investments protected?

The short answer to your question is yes, there is some level of protection for your investments akin to the FSCS for cash deposits. If that’s what you were hoping to hear, I’m afraid the longer answer is less satisfactory. However, there is some good news, which is that from April the protection offered to investors is being increased significantly.

As you probably already know, cash deposits in the UK are reasonably well protected. The FSCS provides compensation cover of up to £85,000 per person (£170,000 per joint account) for cash deposits held at a UK authorised bank, building society or credit union that goes bust, or where money has gone missing through fraud. It also protects temporary high balances up to £1m, following events such as a house sale, for up to six months. Cash held in a Sipp or a sharedealing account is covered under the cash limits of up to £85,000, but note that if your broker banks this at an institution where you already have cash on deposit or at a bank that operates under the same licence as another bank you use, your maximum compensation across both accounts will be £85,000 should the licence holder collapse. Savers should therefore keep an eye on the levels of money they hold directly and indirectly at different institutions.

The FSCS also provides cover for investments, but for nowhere near as much. The current limit is just £50,000 per person per firm. However, as we mentioned above, this situation will improve from 1 April 2019 when investors will be able to make claims for up to £85,000-worth of investments lost as a result of an authorised financial services firm collapsing.

But even with the increased limit, many investors, including you and your family – and particularly anyone trying to build a pension pot for later life – are likely to find that a large chunk of their investment portfolio is completely unprotected.

This doesn’t mean that you would lose everything above the investment limit in the event of a firm going bust. That’s because there are other protections in place to prevent investor losses. First, platforms have to abide by specific rules, namely that client money must be segregated entirely from the provider’s own funds so that creditors can’t take it in the event of a collapse. Hence Isa and Sipp providers keep client money in nominee accounts (almost always pooled), where they are ringfenced from creditors and administrators. (If the nominee company folds, then the Isa or Sipp provider would be liable for any losses.)

Fund managers too are forced to keep investor money segregated from the firm’s own funds for the same reason.

However there are gaps in the 'ring fence' and these were revealed when a small broker called Beaufort Securities collapsed last year. Financial services firms are required to hold capital so that if they stop trading, money will be available to cover all winding-up costs. But at Beaufort, it was discovered that there was no money in the kitty to cover administration costs. Administrators promptly told customers of the failed broker it would be dipping into their funds to pay its costs (initially estimated at £100m). After an outcry, the majority of customers were told that only up to £10,000 would be taken from their accounts and that these costs could be fully reclaimed from the FSCS. In fact the FSCS also agreed to pay PWC direct so that customers didn’t even need to make a claim for compensation.

The fact remains, though, that in such a situation administrators are legally entitled to raid client accounts to pay their costs. The Beaufort debacle shattered the idea that client funds are untouchable. Still, as long as an administrator doesn’t raid your individual pot for more than £50,000 (and £85,000 after 1 April), you should be able to avoid losses because you will be entitled to reclaim them from the FSCS. However you could find that you are unable to trade for a period of time. Most Beaufort clients lost access to their trading accounts for at least 10 months.

We welcome the new limit for investments, but it’s not enough, as we have argued before in the Investors Chronicle (IC 11 May 2018), especially in the context of recent pension liberalisation that encourages us all to take more control of our retirement savings. We’d like a compensation scheme closer to the $500,000 offered by the US equivalent, the Securities Investor Protection Corporation.

In the meantime, all investors should consider the financial strength of their platform and check how they approach investor protection. Unlike with cash deposits, it doesn’t make sense to spread your share and fund holdings across a number of platforms with no more than the compensation limit in each one. This would be difficult and totally impractical to do and would also prevent you from taking advantage of cheaper fees commonly offered to investors with larger pots of money to invest, although you could of course use different providers for your Sipps and Isas.