Capital protection and compensation systems for stock market investors

Investor compensation

Every time you wire your money to a stock or forex brokerage firm, you want to be reassured that it's not going to disappear if the company suddenly disappears. You also want to know who or what will protect you if your broker vanishes into thin air or goes broke.

This is even more important if you're considering sending your funds abroad to a foreign jurisdiction. After all, you might know the investor protection rules of your own country, but what about in other countries or jurisdictions? Is your capital 100% safe there?

Below, we'll take a look at who is looking after your money in foreign jurisdictions and how much compensation you are entitled to should the broker be careless or make unlawful use of your money.

What is an investor compensation plan?

First of all, as a trader, you need to make sure that you understand the financial limits of any legal compensation plan that you are covered by. These plans won't protect you if you lose money due to lousy trading decisions on your part, though. That's pretty obvious, isn't it?!

Compensation systems are only there to protect you from losing your money when a regulated firm goes bankrupt and the reason for your loss is linked to either fraud or incompetence.

In other words, if your brokerage firm goes bankrupt and your money or your stock shares are wiped out, the compensation plan is set up so that you don't lose the shares you've invested in. This is because your assets are supposed to be held in an account that is separate from the company's assets. These are sometimes referred to as "segregated accounts", and are quite common with forex brokers. Even if the brokerage firm collapses, your shares are still technically yours. If they cannot be clearly identified as yours, the broker didn't do its job and it is likely that someone in the company just plain stole from you and others.

You should also be aware that trader compensation plans only cover you if you have done business with a regulated firm that is a member of the compensation system. You will not be entitled to anything if you invested in the stock market via an unregulated brokerage that is operating outside of the law. So due diligence on your part is crucial before you send any money anywhere - make sure you fully understand who is on the receiving end and make sure that they are regulated by a reputable regulatory agency or body. Stay away from brokers that are based and regulated on a small island or territory (Aruba, Bahamas, etc.)

You should also be aware that in many countries there are investments or financial activities that are legitimate but not covered by regulations or by a compensation plan.

Global investor compensation and protection plans

The better known protection plans and jurisdictions are listed below (as well as the individual coverage amounts that they guarantee). Please note that these are the rules that are applicable to investment firms.

  • UK Financial Services Compensation Scheme (FSCS) provides investors compensation of up to £85,000.
  • In Canada, the Canadian Investor Protection Fund protects individual investors up to $1-million for general accounts (stocks, bonds, mutual funds, commodity futures, foreign exchange contracts, etc.)
  • In the EU, €19,999 is the minimum available compensation. However, some countries offer more and there are plans to increase this minimum due to rising savings levels.
  • Luxembourg Association for the Guarantee of Deposits: up to €20,000.
  • Singapore Exchange Fidelity Fund: up to $49,999 (only covers stocks that are on the Singapore exchange, investments in foreign territories are not protected).
  • Hong Kong Investor Compensation Company: up to HK$149,999.
  • In the USA, the SIPC protects clients' cash and securities, such as stocks and bonds that are held at troubled financial firms. The SIPC will protect up to $500,000 in cash and securities; of that, $250,000 may be in cash.
  • In France, the FGDR (Deposit Guarantee and Resolution Fund - Fonds de Garantie des Dépôts et de Résolution) guarantees your stock holdings up to €100,000.

A look at the UK's FSCS:

The FSCS protects authorised banks, brokerage firms and credit unions up to £85,000 per depositor in the event of their insolvency. If deposits or savings are in a joint account the total of FSCS protection doubles to £170,000. FSCS protection is free and automatic. If anything happens to your bank, building society or credit union, FSCS will automatically refund your savings. In the vast majority of cases savings are refunded in less than 7 days.

As of 4 July 2015, some types of high balances of up to £1,000,000 are protected for up to 5 months.

A look at Canada's plan:

CIPF provides protection for property held by a member firm on behalf of an eligible trader or investor if the member firm suddenly becomes insolvent. Member firms are investment dealers that are members of IIROC (Investment Industry Regulatory Organisation of Canada). These investment firms are also automatically members of the CIPF.

CIPF coverage is custodial in nature. CIPF does not provide protection against any other type of risk or loss. If you have an account with a member firm, and that firm becomes insolvent, CIPF works to ensure that any stocks you hold with them at that time are given back to you, within certain limits. Total assets therefore include both securities and cash. In certain circumstances, the CIPF’s role may involve requesting the appointment of a trustee in bankruptcy.

A look at Australia's system:

The National Guarantee Fund, established in 1987 provides a clearing guarantee and investor protection in relation to transactions on the Australian Stock Exchange (ASX). The situations in which traders of a stockbroker may register a claim with the National Guarantee Fund are:

  • where the broker has failed to complete a sale or purchase of securities entered into on the ASX's equities and debt market or where those transactions are required to be reported to the ASX by the stockbroker ("contract guarantee");
  • an unauthorised transfer of securities;
  • contravention by a stockbroker of the certificate cancellation provisions (which relate to the ASX's uncertificated securities system);
  • where a person has entrusted property to a stockbroker who subsequently becomes insolvent and therefore cannot meet its obligations to that person.

The National Guarantee Fund holds about $160 million and is administered by the Securities Exchanges Guarantee Corporation Limited, a subsidiary of the ASX. The basis of the fund was a proportion of the fidelity funds previously held by the capital city exchanges. To this has been added interest from broker accounts and investment income. While the power exists, no levies have been imposed to support the Fund. Payments have been made from the Fund for claims, administration and securities industry development purposes.

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