Segregation and Ringfencing of Client Funds

Q. What if my spread betting provider goes bankrupt!?

I have heard of Global Trader going into financial difficulties just on the exposure of one client - so suppose I open an account with a spread betting firm how safe are my monies? - what happens in the situation that a provider becomes insolvent?

A: The FCA has strict rules covering the spread betting providers conduct of business and financial adequacy.

Regulatory capital: All FCA regulated firms are required to carry out daily Financial Resource calculations to ensure the providers have adequate regulatory capital at all times.

Compensation scheme: In the unlikely event the firm was to go into liquidation individual clients are covered by the Financial Services Compensation Scheme (FSCS). The limit is £50,000 per person per firm for claims against firms declared in default from 1 January 2010.

Segregation of client funds: is available to retail and certain professional clients and involves the company placing client funds in a separate bank account to the firm's own money. In the event of default by a spread betting provider the bank acknowledges that there is no right of offset between the firm's funds and the clients. Should the Firm's bank account become overdrawn, the bank cannot use client funds.

Most spread betting companies will hold your funds in a segregated bank account so in the unlikely event of the insolvency of the company, your funds are fully protected. In such an event, you would be entitled to obtain your full account balance.

In the event that the 'deposit takers' (Banks with whom the spread betting company holds clients' funds) collapse, all client money - segregated and non-segregated would be lost. However, the FCA Compensation Scheme protects and guarantees the first £50,000 of the clients' money. So, if you hold less that £50,000 with a spread betting company, you will be entitled to all of your money if their bank collapsed.

This was good news for the 400 customers or so of a small spread betting provider; Global Trader Europe, which went out of business in 2008. This is another good reason to spread your money across different spread betting providers.

So would any unrealized profits/losses also be respected in the event of unsolvency? The answer to this would be that your positions would be closed at the prevailing market rate and your funds returned back to the original source.

And what if the provider was located in Ireland? Well, I asked this question to Delta Index who are based in Ireland and their reply was as below -:

'Thank you for your enquiry, we currently stand authorized by the Irish Financial regulator and In relation to the safeguarding of client monies, we are already operating exactly as we expect to be when fully regulated. All client bank accounts are specifically named "Delta Index Section 52* client asset accounts'. In this regard it is clear that the assets do not belong to the firm and are subject to the requirements to the Financial Regulator's Client Asset Requirements under S.I. No. 60 of 2007, the European Communities (Markets in Financial Instruments) Regulations 2007 (MiFID).'

Q. But how ringfenced are client accounts in practice? My understanding is that accounts are only ringfenced from the firm, not from each other...

and basically your major risk is other clients... so the ring fencing isn't that useful?

A: I've asked this to the powers of Capital Spreads and their reply was the following:

'We have spoken to our compliance department and they have confirmed the following information for us.

The clients' funds are kept in Client Money Bank Accounts. Those accounts are ring fenced. That means that according to FCA regulations those funds cannot be used by administrators in case London Capital Group Ltd. goes into liquidation. The FCA regulations do not require us to have a Client Money Bank Account per each client. As far as we know no spread betting company offers that facility. At the end there is no difference as far as the protection of the clients' funds is concerned. The exposure of the client is with LCG Ltd and not with other clients.

The Client Money Bank Accounts are kept in institutions regulated by the FCA. The treatment of Client Funds is determined by the FCA and that is the treatment we provide to Client Funds. It is the standard treatment given to Client Money by all spread betting firms, as far as we know.'

Further Simon, Managing Director at Capital Spreads has further commented: 'LCG (Capital Spreads) has always taken the extreme view of this and considers all clients to be 'retail'. this means that all client funds MUST be held in a segregated account (and all winning positions as well) with a 'reputable bank' (and i realise that this may be considered an oxymoron by some).'

'This means that LCG cannot use client funds as margin against its own positions which have been taken out as hedges against client bets. We must use our own funds. CFD's clients are generally (but not necessarily) considered to be 'professional'. This means that their money can be mixed up with the CFD providers own money and used pretty much as they see fit. This generally means that your funds are not as safe with a CFD provider (a much more respectable product) than with a spread betting account/provider.'

'A classic example was the failure of Global Trader at the start of 2008. Because of the losses of one position, which the client could not cover, in an illiquid stock the company could not get out of the hedge. The company was suspended but all the other client funds, because they were not in segregated accounts were at risk.'

However, from personal experience I can say that different providers have different policies and procedures so it is always best to talk to them and have it confirmed in writing. For instance I know for a fact that CityIndex does not automatically hold client margin money in UK banks; they reserve the right to deposit client margin money with non-UK banks or 'third parties'...

Q. How often do FCA brokers conduct audits? How often do you have to report client monies?

A: Regulated FCA brokers are obliged to do audits twice a year with reports being sent on a daily basis to the regulatory authority. Client balances are reconciled twice every day. Brokers having to keep client monies in a separate bank account means that if the broker is bankrupt, this doesn't extend to client monies. The problems start when rogue brokers use 'trust accounts' as a marketing gimmick as opposed to treating it like a real trust account. Of course if the regulator finds this out there are huge penalties and possible loss of license.

It is worth noting that to apply for an FCA license you will need specialised lawyers to prepare the application (takes about 4 months) before the actual submission and then you will have to allow some 6 to 9 months before you get approved. You also need to have a going concern by the time your business is authorized which in practice means that you would have already accumulated costs of 1m to £2m before you are even permitted to launch. Once operational, you will also have costs of about £150k to £250k per month. You are unlikely to see much business for the first few months so by that time setup costs would likely to reach £1.5m to £3m.

Q. Does FCA protection extends to my open profits in the event of a FCA-registered broker going bankrupt?

A: Unfortunately, when the worst happens and a broker encounters financial difficulties it can take the administrator substantial time to reconcile all the open trades and liquidate them. The running profit or loss you have at the time the provider declares the firm to be in administration will not be mirrored once the administrator comes to close your trade. It could be better or worse but the running profit or loss will reflect in your final payment. So to answer your question, yes, you will get paid back on any running profits you have once the administrator liquidates and closes your trade as long as any payout from the FSCS is within their maximum payout.

Q. What is the situation in Ireland? If an Irish regulated spread betting firm goes belly up is my account balance at risk?

A: The protection afforded to bank deposits, by the Irish Government, does not extend automatically to investment companies, such as spread betting companies. However, I've taken some time to quiz the providers separately and their replies are given below:

DeltaIndex: 'In the event of Delta Index going bankrupt, your funds are protected up to 20,000 euros (refer to which is the Investor Compensation Scheme, also see section 17.3 of our terms and conditions, on the DeltaIndex website) The Client monies are held separately from Company money. Only money used as Margin is at risk in the event of Bankruptcy, the remaining money is held separate.'

Q. But won't spreadbetting firms go bust because of the winners continuing to make money?

A: This is simply untrue; spread betting providers will not go bust because of a few clients making money. For one providers have an edge (due to the spread) since most traders lose, second spread betting firms are able to buy lower and sell higher (spread) and third they are able to hedge excess exposure; for instance suppose there are two opposing bets, a 2000 Pound / point long FTSE and 2100 Pound / point short FTSE - they can simply short 10 FTSE contracts.

Q. Providers usually thrive on volatility so why have some spread betting companies registered losses in the collapse of the equity markets?

A: Spread betting is a geared product meaning that clients are only required to deposit a small amount to control a much bigger position - this percentage is typically 10% for liquid shares so a client could potentially take £100,000 worth of exposure in a share with just a £10,000 deposit with the spread betting provider. If the market moved against the client, he would simply be required to put in additional funds to cover the 10% margin.

This usually works 99% of the time but in the last 18 months there have been situations where stock market prices have fallen by much more than 10 per cent in a matter of days (especially in the financial sector). The consequence of this was that a number of spread betting clients lost material amounts and some were unable to cover - this was especially so with credit accounts and so companies were left trying to recoup their debts. Even though strictly speaking the contracts are legally enforceable some clients simply couldn't afford to pay and some providers like IG Index and CityIndex were left with substantial losses on their books.

This problem typically affects high rollers and has affected some providers more than others - for instance Capital Spreads had very few of these cases as it doesn't offer credit accounts and targets the mass market.

Q. What is this talk about my funds being less secure with a stock broker's nominee account?

A: This usually applies to physical shareholdings (not spread betting). Most brokers today hold client shareholdings in nominee accounts; in such cases it is the broker's name that appears on the register. In the past most shares were held in the form of certificates but since most shareholdings are traded online nowadays, brokers find it convenient to use their own nominee account as an electronic record in Crest (Crest is the storehouse for non-paper based transactions in the UK).

For most personal investors it doesn't make any difference whether a nominee account is used apart from the security aspect. Naturally having your name on the register is best since this direct connection is not present when shares are held in a nominee account (in such cases it is the broker's name that will show on the register). The law does protect personal investors so even in the event of insolvency funds held in a nominee account cannot be used to pay creditors if these are held on behalf of clients and the FCA also provides additional layers of protection; although this still doesn't equal the same level of security as a Crest account. If you worried about your shares being held in a nominee account you can always have your own Crest account (you will need to apply for a Crest personal membership) in which case your name will appear on the share register of the company in which you are investing.

The way of holding shares can also have further significance; for example in the case of companies that offer scrip dividends (i.e. offer you the option to get your dividends as shares), this option may not be available for nominee account holders since the company will have problems identifying you.

 ...Continues here - What if my Spread Betting Provider goes Bankrupt!?

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