Investment platforms: navigating the maze of investor protections

• Describe the regulatory checks and balances that apply to investment platforms.
• Explain how the Government compensation scheme will cover losses.
• Explain how the compensation applies to the different products on a platform.

Investing in funds and shares has never been easier or more popular, and this is thanks in no small part to the increased accessibility of investment platforms.

Platforms are now big business. According to June 2021 figures from platform research consultancy Platforum, the market sits at £785bn in terms of assets under administration, a quarter of which is managed by financial advisers.

Investors will want reassurance their money is safe. However, many platforms aren’t yet household names in the way banks, building societies or insurance companies are, so advisers might find themselves fielding questions about the security of platform cash and assets.

Given there can be different entities involved in a platform, not to mention different products, this can make it hard to figure out what is protected and how – and add to that the fact that the investment market is a heavily regulated sector with various protections and fall-backs in place.

If asked about investor protection, therefore, the first thing to check is the exact scenario being contemplated – or, more precisely, which entity has become insolvent. For me, this is the best way to contextualise how these protections work.

In this article, I look at how the Government compensation scheme works in each scenario. I also look at what wider preventative and protective measures are in place.

Insolvency of a bank

Before we look at investment protection, let’s first look at cash protection.

The primary purpose of investment platforms is to hold investments. However, a client will almost always hold some cash in their investment account. This is typically cash that’s waiting to be invested or that’s there to cover fees and charges.

Given that platform providers are not typically authorised as deposit takers, they place client cash with other financial institutions. As we’ll look at more in the next section, this cash is governed by the FCA’s Client Asset Sourcebook (CASS) rules, which means it must be kept separate from the provider’s own cash.

If a bank holding platform cash were to become insolvent, the cash would be protected by the Government-backed Financial Services Compensation Scheme (FSCS).

It’s important to note that the FSCS ‘looks through’ any wrappers or accounts on the platform. In other words, for the purposes of the FSCS, it’s as if the client was holding that money in their own personal bank account.

The amount of cover is £85,000 per person per banking licence. Halifax and Bank of Scotland are separate brands, for example, but they both operate under the same HBOS licence.

Clients may therefore ask to check which bank a platform uses. However, many platforms will likely use a selection of banks, and the exact percentage of cash held with each bank may change on a regular basis. This means it might not be possible to pin down to the exact pound the amounts clients are deemed to hold with an individual bank.

Insolvency of the platform provider

The scenario some clients may be more concerned about, however, is where a platform provider itself becomes insolvent.

Before looking at compensation on insolvency, it’s worth looking at the regulatory checks and balances in place that aim to prevent an insolvency situation occurring, not least because it’s the part of the protection framework that clients are typically not familiar with.

In terms of client cash, the FCA CASS rules require platforms to hold cash in trust accounts with authorised UK banks. These accounts carry a client money designation and are monitored and reconciled on a daily basis. This prevents client cash becoming mixed with the platform provider’s own cash. It also means there’s an accurate record of what cash belongs to which investor.

In terms of investments, these must be held separately in the name of a nominee company or authorised third-party custodian. This means again that there should be a clear line between the assets belonging to the provider and those belonging to their customers.

Both these measures should make it straightforward to return funds to investors or transfer them to another platform in the event the provider runs into difficulty.

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

They 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.

If, despite these rules, a platform provider were to become insolvent, and a client suffered losses as a result of the insolvency, they would be protected under the FSCS up to £85,000.

It’s worth noting there can be a degree of flexibility in how the £85,000 is applied in practice. In March 2018, the FCA applied to the High Court to place fund management firm Beaufort Securities into administration. The FSCS stepped in, not to compensate losses, but to cover PwC’s costs as administrators.

Beaufort Securities

The FCA, along with the US Department of Justice, had been investigating Beaufort over alleged securities fraud and money laundering. At the time, Beaufort had around 17,000 retail customers in the UK.

Beaufort had been running some of its clients’ money on a discretionary basis and using its discretion to put some customer funds into unlisted, illiquid and otherwise esoteric investments, a large number of which subsequently had to be written down.

Individuals from PwC were appointed as administrators, and they forecast insolvency costs of £100 million, later reduced to £55 million.

Initially, it looked like Beaufort customers would have to foot the bill for PwC’s costs. The money and assets were held in segregated accounts as per FCA CASS rules, so they were separate and identifiable. The issue was that regulations allow administrators’ costs to be passed onto customers if there was insufficient capital in the insolvent business to pay them.

However, PwC and the FSCS came to an agreement that the latter would cover PwC’s costs rather than compensate customers directly as would typically be the case.

PwC started paying back client cash and assets in September 2018, and by April 2019 the majority of Beaufort’s retail customers had received their money back.

Insolvency of a fund manager

It is also possible that the manager of an underlying investment fails in a way which means that it is unable to return investors’ money.

UK-based fund managers are authorised by the FCA. If a fund management firm failed, then the £85,000 FSCS limit would apply per investor per failed firm.

Therefore if the investor has all their money invested in units managed by the same fund manager, then only one £85,000 compensation limit would be available to cover all the holdings.

Whereas, for example, if Manager A and Manager B both failed at the same time, and the investor held investments in the funds of both, then two £85,000 limits would be available to cover their respective investments.

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 became insolvent, there may be a compensation scheme in that jurisdiction, but losses are unlikely to be covered by the FSCS.

And if a fund simply fails to perform, and ends up with liabilities greater than its assets, there is no formal recourse for compensation. This is investment risk and it sits with the investor. The same applies for the failure of listed companies.

Insolvency of a wrapper provider

Many investment platforms hold different tax wrappers, principally SIPPs and ISAs. Given both of these products require FCA authorisation, this adds another slant to the protection situation.

First, though, in terms of preventative measures, assets in trust-based SIPPs are held by the SIPP trustee, which is a non-trading company functioning as a bare trustee. This means that the SIPP cash and assets are held by a separate legal entity to the administrator.

There are also FCA capital adequacy requirements for pension providers. As with the capital adequacy rules for platform providers, these require administrators to hold capital in reserve that they could draw upon in the event of the firm being wound down. Firms that permit more esoteric and unusual investments are required to hold larger amounts of capital.

If you’re looking at a platform proposition where the SIPP administrator and the platform are part of the same overall business, the provider will be subject to both sets of capital adequacy rules.

In terms of compensation, pension providers and ISA managers are regulated by the FCA. Therefore, there ought to be cover of up to £85,000 through the FSCS.

What is unclear from the publicly available information or from previous insolvency cases, however, is whether a platform client with a SIPP, ISA and dealing account would be eligible for three sets of £85,000. This is on the basis there could technically be three entities within the platform’s company structure, each separately regulated by the FSCS.

Admittedly we’re looking at an extreme worst-case scenario here, so it’s unlikely to be an issue. Remember as well that in previous situations, the FSCS has tried to be flexible where possible.

Non-platform protections

Finally, it’s also important to consider how the platform businesses themselves are performing.

Platforms that have a consistent track record of profitability or that are part of a larger group should be able to ride out any storms. Advisers might also look at things like permissible investments, regulatory capital and platform IT capability when assessing a provider’s robustness.

While this isn’t a type of formal protection or compensation, it is another way advisers can add value to the process and demonstrate to clients that their investments are secure.

This article was previously published by FT Adviser