How well protected is client money on investment platforms?

With the current pandemic and broader economic lockdown, many clients are understandably concerned about how secure their money is. Martin Jones looks at investment platforms and what protections are in place should the worst come to the worst.

According to the FCA’s Investment Platforms Market Study, the platform market in 2013 stood at £250 billion in assets under administration (AUA).

By 2017, when the study began, this had doubled to £500 billion, driven by an increase in investor numbers of over two million.

Over 60% of that AUA figure is managed by advisers. So whether it’s pension, ISA or non-wrapper money, a lot of client wealth is now sitting on investment platforms.

With the economy in lockdown and with portfolios taking a beating, it’s worth revisiting the protections in place for money held on those platforms.

Fund of last resort

Many clients will have heard of the Financial Services Compensation Scheme (FSCS). This is the Government-backed lifeboat fund that provides compensation in respect of claims against authorised firms where the firms have failed and are unable to settle claims themselves.

Authorisation in this context can be by the Financial Conduct Authority (FCA) or the Prudential Regulation Authority (PRA), so it covers platforms, stockbrokers and banks.

When explaining how the FSCS works, it’s important to focus on what scenario is being contemplated and which authorised entity has become insolvent.

Looking first at how cash would be covered, platforms will typically hold uninvested client cash with a bank or panel of banks. If we’re looking at a scenario where an authorised bank fails, cash would be protected up to £85,000 per client per banking licence.

This applies to cash held within wrappers, which is important to mention. Clients will also need to consider what cash they hold personally, as this is aggregated with platform cash.

In terms of investment funds on a platform, UK-based fund managers are authorised by the FCA. Clients will therefore be protected up to £85,000 if a fund manager becomes insolvent and, as a direct result of this, investors lose money.

When it comes to exchange-traded funds (ETFs), the same principle applies. However, a large proportion of ETFs are domiciled outside the UK, typically in the Republic of Ireland and Luxembourg. If the manager of an overseas-based ETF becomes insolvent, there may be a compensation scheme in that jurisdiction, but it’s unlikely to be covered by the FSCS.

The scenario that some clients may be more concerned about, however, is where a platform provider itself becomes insolvent. If that were to happen, and clients were to suffer a loss because of the platform provider’s insolvency, they would be protected under the FSCS up to £85,000 per client.

When it comes to platforms, though, it’s important to remember that the insolvency of the provider doesn’t directly lead to clients losing money. There are other important protections outside of the FSCS, which is what I’ll come onto next.

Prevention better than cure

From our experience, a lot is made of the FSCS. This may be because it’s straightforward to understand and it comes with a Government guarantee.

There is also, however, a system of protections in the background governed by rules such as the FCA’s Client Asset Sourcebook (CASS) rules. These are designed with the purpose of keeping client funds safe if an investment platform were to become insolvent and unable to continue operating. And it might actually be these that provide more comfort to nervous investors.

In terms of client cash, the rules require platforms to hold cash in trust accounts with authorised UK banks. These accounts carry a client money designation, and they’re monitored and reconciled on a daily basis.

As for client assets and investments, these must be held separately in the name of a nominee company or authorised third-party custodian.

These measures prevent client cash and assets becoming comingled with those belonging to the provider, which in turn should make it straightforward to identify and return funds belonging to investors should the worst come to the worst.

There are also capital adequacy rules that providers must adhere to in the form of the Capital Requirements Directive. This requires authorised firms to hold enough capital in reserve that they can cover any ongoing costs in the event of an extreme but plausible wind-down scenario.

These rules also require providers to assess their business risks on an ongoing basis to make sure they are holding an appropriate amount of capital in reserve. Providers will typically go over and above in terms of holding the capital needed to satisfy the minimum requirement.

In terms of selecting the right investments in the first place, there is no substitute for qualified financial advice, particularly with more ups and downs to come. But hopefully clients can also take comfort that there is a system of protections built into the fabric of platform regulation.

This article was previously published by Retirement Planner.