If your Stocks and Shares ISA or SIPP provider goes bust your money and assets are protected by the Financial Services Compensation Scheme (FSCS) if the provider is a firm regulated by the Financial Conduct Authority (FCA). The primary protection you enjoy is that the FCA forces authorised firms to separate their money and assets from your money and assets, but if there's a shortfall the FSCS steps in as a last resort up to a value of £50,000. If you hold a cash ISA with an authorised firm your money is covered up to a limit of £85,000 per person, per authorisation. If you have been mis-sold an investment by a firm that has failed you may be eligible for compensation up to £50,000.
What is the Financial Services Compensation Scheme?
The FSCS describes its role on its own website as follows:
FSCS is the UK’s statutory fund of last resort for customers of authorised financial services firms. This means it can pay compensation if a firm is unable, or likely to be unable, to pay claims against it. FSCS is a non-profit-making independent body, created under the Financial Services and Markets Act 2000 (FSMA). It is funded by levies on authorised financial services firms. FSCS does not charge individual consumers.
Any company that sells financial services in the UK has to be regulated by the Financial Conduct Authority (FCA) and this is a very rigorous process. Once the FCA approves the company to deliver financial services the company is said to be "authorised". The criteria for authorisation include:
- Segregation of client money from the firm's own money.
- Complaints: If a client has a complaint that has not been answered by the firm to their satisfaction it can complain to the Financial Ombudsman Service.
- Capital Adequacy: Authorised firms must have sufficient capital to weather periods of financial difficulty, with a minimum of £50,000 or more depending on the nature and riskiness of its business.
- FCA Handbook: The behaviour expected from an authorised company is laid out in detail in thousands of pages of principles and rules in the FCA handbook.
Authorised companies are the bodies that fund the Financial Services Compensation Scheme.
In 2018 the FSCS had an income of £578 million from levies on 20,180 authorised firms in the UK and paid out £445 million in compensation.
The largest payout category was Life and Pensions Intermediation, where the FSCS said:
We continued to receive claims in relation to advice given by Independent Financial Advisers to customers to transfer existing pension arrangements into Self-Invested Personal Pensions (SIPPs). In the vast majority of these claims the customers invested in high-risk, non-standard asset classes within SIPPs, many of which become illiquid and potentially insolvent. Over the past year, FSCS has paid compensation of £112m for SIPP related claims compared with £105m in the previous year – an increase of 7%.
General Insurance Provision claims were the second largest payouts and these were mostly for Payment Protection Insurance (PPI) mis-selling.
Investment Intermediation Claims were the third largest category of claims by value. This was mostly claims against Independent Financial Advisers for negligent advice to invest in unsuitable funds and other types of investment. Two investment firms were placed into the "Special Administration Regime", which is an insolvency regime for investment firms facilitating client assets to be returned. These were Strand Capital Limited and Beaufort Securities Limited.
How to check if a firm is authorised
The protections offered by the FSCS and the Financial Ombudsman only apply to authorised firms. That means you should always check that the company that you use as an investment platform (or financial adviser) is authorised by the FCA. The link to check is here:
Here's an example search for "Vanguard" on the FCA register website. The important column is the one labelled "Status" and the fact that the firm is "Authorised" which means you will be eligible for FSCS protection and will have recourse to the Financial Ombudsman service if you want to make a complaint.
Some companies, called clones, copy authorised companies in order to run a scam to get your money. For example, if you look up the very popular Hargreaves Lansdown investment platform on the FCA register you will get results that look like this:
Notice the entry at the bottom "Hargreaves Lansdown (clone)". If you click on the "Hargreaves Lansdown (clone)" text you get the following warning. The FCA recommends that you call the properly authorised company back on the switchboard number listed in the FCA register to check they're not a clone before you give them any information.
Segregation of your money & assets
This practice is enforced by the Financial Conduct Authority on authorised firms and protects your money and assets in the event that your investment platform goes bankrupt. The platform will have bank accounts where it keeps its own money and a separate set of bank accounts containing the money of its clients. If you buy shares and bonds with an investment platform these will be held separately in a custodian account. The FSCS makes the distinction between money and assets very clear:
- Client Money is the cash held for you within your portfolio. Client money can arise, for example, from cash that customers have paid to the firm that has yet to be invested, or from dividends or other income received in relation to their assets.
- Client Assets are the individual stocks, shares and other investments that form the rest of your portfolio.
This segregated setup means that in the event of the firm going bankrupt administrators will be able to easily differentiate between what's yours and what belongs to the firm. The administrator will first use the firm cash and assets to settle the firm's debts with its creditors. This is the section of the FCA Handbook in the rule book called CASS (Protection of Client Assets and Money) that lays out precisely how authorised companies should segregate money.
One example of a breach of this rule occurred in 2014 when Barclays failed to clearly segregate its own assets from those of its clients. It failed to apply FCA rules when opening 95 custody accounts in 21 different countries, incorrectly recording which company within its Investment Banking Division was responsible for the assets in its accounts. It also failed to establish appropriate legal arrangements with custodians it used and had basic flaws in account naming and this incorrect data suggested assets belonged to Barclays instead of its clients.
The FCA takes this very seriously. As David Lawton pointed out in a speech shortly after the Barclays fine was levied:
"The doomsday scenario of a large firm failure still remains a real risk, and if CASS rules are not complied with, clients face delays in return of assets, extra costs and, worst of all, losing their assets. The FCA is not willing to accept this risk."
What happens if a Stocks & Shares ISA or SIPP provider goes bust?
Shares in a Stocks & Shares ISA or a Self Invested Personal Pension are protected differently from cash in a Cash ISA. They are called "risk-based investments". With investments, the level of protection is £50,000 per person, per authorised firm (increasing to £85,000 on April 1st 2019).
The FSCS does not provide compensation if you invest in a stock which loses value, or if your shares perform badly or if the share price goes to zero when a company goes bankrupt. It does cover you if you lose money because an authorised firm gave you bad advice or negligently managed your investments, and you are covered up to £50,000 if the firm that gave you bad advice fails.
For an investment claim to be eligible for compensation, it must meet all of the following criteria:
- The firm (or its principals) no longer has sufficient funds to meet the compensation claim itself.
- The advice you received to buy the investment must have been given on or after 28 August 1988.
- The firm that advised you must have been authorised by the appropriate regulator to do so at that time.
- You must have lost money as a result of the advice you were given.
You would claim against the company that gave you bad advice, not the company your investment is held with.
Another situation in which you may receive compensation is if your platform stops trading and has not put aside enough cash to pay their administrator. In this case the administrator may sell client assets to pay their fees, in which case you may not receive back all your assets and could file an FSCS claim. Hargreaves Lansdown say this about the payment of administration fees in their article "How safe is your investment?":
Self Invested Personal Pension
A Self Invested Personal Pension is a pension that you manage yourself. It has tax benefits, but you can't take out any money until you reach the early retirement age, which is currently 55. Investment platforms usually offer one or more of the three types of investment accounts: Individual Savings Accounts (ISA) where you don't pay any capital gains or income tax, SIPPs and General Investment Accounts which don't have any tax benefits.
However, sometimes providers may go bankrupt, although this is extremely unlikely for the larger platforms.
In January 2018 the FSCS published this article about three SIPP providers some of whose clients had applied to the FSCS for compensation. Click on the image to read the full article.
The problem was that these SIPP operators "failed to exercise reasonable care and skill, breached regulatory requirements and/or breached trustee duties". The description of the type of investments, and the way they were sold, is deeply troubling (we have highlighted the most worrying parts in bold):
"Many of the investments were higher risk such as oil investments, foreign hotel room investments and foreign vineyard investments and made by consumers with little investment experience and modest funds to invest. Often the investor was not actively looking for alternative pension investment opportunities but made the investment following a cold call by an overseas introducer who referred the consumer to the SIPP operator on a non-advised basis. In some instances, investors transferred all or the vast majority of their existing pension from an occupational pension scheme into the SIPP... Many of the underlying investments held via the SIPPs are illiquid and have little or no current value resulting in consumers having lost a substantial portion of their pension pot."
What happens if a Cash ISA provider goes bust?
If you hold a cash ISA with an FCA authorised company (such as a bank or building society or investment platform), the FSCS deposit guarantee scheme offers protection for up to £85,000; this applies per person, per institution. In fact, it's a bit more complicated than that because "per institution" actually means "per banking license". Multiple companies with the same banking license (or "authorisation") fall under the same FSCS umbrella so you wouldn't be spreading your risk if you have a deposit with one or more of them.
The FSCS website provides a list of UK authorised banks and building societies here
If you look at the section entitled "Some of the banks and building societies we protect" and select "Halifax" you will see all the institutions which share the same authorisation as Halifax:
Halifax operates under the banking authorisation of Bank of Scotland plc, this means that you might only be protected up to £85,000* for the total amount of money you have across the brands covered. Other brands operating under the Bank of Scotland plc include Capital Bank, Intelligent Finance, Saga and St James’s Place Bank
Banks and building societies continually merge so it's worth checking back on the FSCS site to ensure that your funds are still under the insured limit. There is also an interactive tool that allows you to check whether your deposits are protected.
If you enter £45,000 deposited in savings in Halifax and £45,000 deposited in savings with Saga you get the following warning:
What happens if a fund manager goes bust?
Segregation of assets means that the shares and bonds in a fund are held by a custodian. In the event of the manager going bust the assets are still owned by you so this would be more of an inconvenience rather than a risk of loss.
Vanguard provides this diagram illustrating how there is three-fold protection of the assets in their funds (regulatory, trustee/depositary oversight and internal risk controls).
The FSCS does not protect you from a fund losing all its value. Whatever the legal wrapper for the fund (Exchange Traded Fund, Open Ended Investment Company or Investment Trust) it is considered your risk if the fund becomes worthless. However, if you can prove that you bought the fund because of bad advice from an authorised financial adviser then you may be able to claim against the adviser, but not the fund manager.
Another recourse could be that the advertising approved by an authorised company for a product failed to meet the FCA principle of being "fair, clear and not misleading". This might be the case if the advertisement fails to make the risks of a product clear. This was the issue with advertisements for mini-bonds issued by London Capital and Finance:
A mini-bond is a very risky, unlisted debt security, typically issued by small businesses to raise funds. To see an example try googling "burrito bond". Mini-bonds typically offer high rates of return. The statement from the FCA went on to point out that mini-bonds are a form of corporate bond and as such have no FSCS protection:
Mini-bonds can be attractive to investors because of the interest rates on offer. However, prospective investors need to understand the associated risks. Mini-bonds are usually illiquid as they are not easily traded, unlike listed retail bonds, which they are often compared to. They can also be high risk, as the failure rate of small businesses can be high. Additionally, as with other corporate bonds, there is no Financial Services Compensation Scheme (FSCS) protection if the issuer fails.
The problem was not the mini-bonds themselves but the promotion of the mini-bonds. The advertising had to be approved by an authorised company and it is the duty of that company to ensure the promotion is fair, clear and not misleading.
Issuing mini-bonds is not a regulated activity, so firms issuing mini-bonds do not need to be authorised by the FCA. However, when an authorised firm approves a promotion for mini-bonds, they must ensure that it is in line with FCA rules, and that the financial promotion is fair, clear and not misleading. This means, for example, that risks are appropriately communicated.
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