How are regulated investments protected?October 26th, 2012 by Dan Woodruff
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There is a common question asked by clients: how are my investments protected if something goes wrong? This article aims to show how regulated investments are protected. Obviously, this does not apply to unregulated investments (so be warned if you have money in such schemes). It should be pointed out that by its nature investing comes with risk, but it is extremely unlikely that the financial institution will fail. Nevertheless experience tells us that this is a possibility, which is why the protections outlined below exist. In addition, this article does not cover general investment risk of loss, which is a fact of life for such products (investments can go down as well as up).
- How are regulated investments protected?
- Information on the Financial Services Compensation scheme (FSCS)
- What happens if your product provider fails?
- When you are not protected
Research into financial strength of companies
When we conduct research to recommend investment plans, part of this process includes assessing the financial strength of the product provider. We do this by using ratings agencies which provide us with insight into their opinion on the ability of that company or platform to meet its liabilities in the event of insolvency. This is a good indication of the strength and stability of the companies we recommend, but we do have to remember that this is based on opinion, which can sometimes be wrong.
FSA Client Asset rules (CASS)
Financial services providers must ensure that they protect your cash in an appropriate way. To this end they will keep all client money separate from the assets of the financial institution so that in the worst case scenario this will not be affected. It is typical of investment companies to hold your cash in a trustee or nominee account to keep your investments protected.
Further to this, financial instituions typically spread cash around a number of different accounts with different banks. This helps to spread the risk of default.
The Financial Services Compensation Scheme (FSCS)
This is a fund set up by legislation and paid for by a levy of all regulated financial institutions (including financial advisers, banks and investment companies). If your investment provider becomes insolvent you can make a claim on the FSCS.
What if my investment provider becomes insolvent?
Investment institutions are covered by the investment business section of the FSCS. The maximum level of compensation available to you is £50,000 per person, per institution. Therefore, if you hold a joint account with an investment provider which fails, your investments are protected up to £100,000.
Cash deposits held within investments
Deposits held in cash accounts of investments (such as wraps or cash ISAs) are protected by the depositor protection section of the FSCS. This means that up to £85,000 is protected per person, per institution. Therefore if one of the banks which holds your deposits fail you have a significant level of cover. You should always remember that if you owe money to the same institution then this will be taken into account before a claim is paid.
Investment funds such as OEICs and unit trusts operate within strict rules. They must appoint trustees or depositories to control their actions. They are also required to ring-fence client cash away from the control of the fund manager. Trustees and depositories have wide powers to inform the regulator if the fund manager is acting inappropriately, or can even remove the fund manager.
If a UK fund manager becomes insolvent you can call on the protection of the investment business section of the FSCS. This protection applies no matter what type of product you hold (investment account, ISA, investment bond or pension plan). You can make a claim for each fund manager that you hold. Therefore, by spreading your investment around a number of fund managers you benefit from additional protection as well as being able to choose from the best in each investment category.
In practice this would work as follows:
Say you hold £100,000 in an individual investment account with XYZ investments. In that account you hold 2 funds: £25,000 in fund A and £75,000 in fund B.
If XYZ investments fails and your account is lost (which is unlikely), you would be able to claim £50,000 from the FSCS.
If fund A fails all your investments are protected – the full £25,000;
If fund B fails you could reclaim £50,000 but would lose £25,000.
If you invested directly with the fund managers the result would be the same.
Foreign fund managers are not covered by the FSCS unless they are regulated in the UK.
Most UK based investment bonds carry an element of insurance to them to provide tax advantages. Therefore investment are protected under the insurance business element of the FSCS. This means that these products are protected up to a maximum of 90% of the value with no upper limit.
The level of protection available to pension plans varies according to the structure.
Most trust-based schemes such as SIPPs are protected by the investment business section of the FSCS and so the pension provider would offer protection for the first £50,000 held. Of course, you would also benefit from the protection from individual fund managers.
Traditional insurance based pension plans usually qualify for the insurance business element of the FSCS. Therefore these provide protection for up to 90% of the value of your assets with no limit.
This article seeks to explain how you are protected in the event that something goes wrong. In practice this is extremely unlikely, and often a provider is likley to be bought by a competitor before disaster strikes.
Your main concern should be is you hold assets in an overseas arrangement, or in an unreguolated scheme since the levels of protection outlined in this article will not apply.
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Dan Woodruff of Woodruff Financial Planning discusses the free Investment Management guide and video series, plus how this can help you manage your assets.
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