Protection for platform investors – do clients and advisers still need to be nervous?

Recent high profile broker failure highlights the importance of platform due diligence. Martin Jones, Technical Resources Consultant at AJ Bell, looks at what protections are in place for platform investors and whether they are still sufficient.

The insolvency of broker Beaufort Securities filled a great deal of column inches earlier in 2018.

Customer assets, we had assumed, would be always ringfenced against all eventualities, which meant there was real consternation when it was announced that administrators PwC could dip into those assets to cover their fees.

There was also shock at the size of PwC’s fees – initially estimated at £100m, albeit later revised to £55m.

It’s now become apparent that the Financial Services Compensation Scheme (FSCS) will cover individual losses up to £50,000 incurred as a result of PwC’s fees, meaning the number of customers left out of pocket is likely to be no more than a dozen.

This is a better outcome than many initially feared. But for a few months, however, there was a great deal of uncertainty, not only for Beaufort customers but also customers of other investment platforms, as a wave of mild panic rippled through the industry.

The question a lot of investors were asking was whether the Beaufort situation had highlighted a flaw in the consumer protections or whether these systems still remain sufficiently robust.

Now the dust has settled, a more balanced assessment shows that investors might have less cause for concern than initially feared.

System of protections

With most brokers and platforms, client money and assets are ringfenced from money and assets belonging to the platform provider. This is as per the FCA’s Client Asset Sourcebook (CASS) rules, which are designed to keep client funds safe if firms fail and exit the market.

For client money, this will typically involve holding cash in trust accounts with regulated UK banks. These are designated as client money accounts and are monitored and reconciled on a daily basis.

Meanwhile, client assets will be held separately in the name of a nominee company or by an appropriately authorised third party custodian.

Therefore, if a platform provider fails, there should be a clear line between the assets belonging to the provider and those belonging to their customers. This should make it straightforward to return investors’ assets or transfer them to another platform in the event the provider runs into difficulty.

Capital requirements

In addition, there are capital adequacy rules, which also serve as a form of protection. Under the Capital Requirements Directive, regulated firms are required to hold sufficient capital in reserve to cover the costs of an extreme but plausible wind-down scenario.

They are also required to assess the risks faced by the business on an ongoing basis in order to ensure that that they hold sufficient capital to manage those risks.

Providers are of course permitted to hold more capital in reserve than the minimum required by the capital adequacy rules, so the precise level of capital will vary between providers. Certainly a firm that is well run and well capitalised is unlikely to pose a risk to customers’ holdings.

Financial Services Compensation Scheme (FSCS)

And in the event that the above protections prove insufficient, and a regulated investment firm goes under leaving customers with losses, there is also the safety net of the FSCS. This will cover losses of up to £50,000 per investor per failed firm.

Beaufort – a unique situation

It’s worth also reflecting that the Beaufort situation was the result of a fairly specific set of circumstances.

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 have subsequently had to be written down.

Many mainstream platforms, however, operate on an execution-only basis and place limits on what investments are permissible on their platforms. And where there is discretionary activity, many brokers use only listed securities.

This doesn’t mean there will never be illiquid stock, but it means money is less likely to find its way into them, and it will generally be easier to return funds to investors.

None of this is of course reason for complacency, however, and it’s important that investors and advisers continue to keep their preferred platforms under the microscope.

If they can withstand the scrutiny in areas such as permissible investments, company ownership structure, financial strength, regulatory capital and platform IT capability, there is good reason to be confident in the viability of most mainstream platforms.

Technical Resources Consultant

After completing his post-graduate studies at Lancaster University, Martin spent two years working for a leading insurance company before joining AJ Bell in April 2007. Martin worked initially on the AJ Bell Investcentre product before moving to a technical role in 2009.

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