Compensation systems for stock market investors

Investor compensation

Every time you deposit money in a bank or in a brokerage firm, you want to make sure that it's safe. So the most important question every trader should ask himself before wiring money to a stockbroker is: "What protects me if this company goes bankrupt?"

This question is all the more important if you're considering using a foreign broker. After all, most traders are only familiar with the investor protection rules of their own country. But these rules do not apply when you place money with a foreign financial firm.

This article examines the limitations of investor compensation schemes in a number of countries. This is only a summary - you should check the details yourself before opening an account abroad.

How do investor compensation systems work?

First of all, make sure that you understand the objectives and limitations of these legal compensation schemes. They don't protect you against your losses on the stock market.

This is true even if the reason you lost money is because the stock you invested in turned out to be a fraud. These 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 due to either fraud or incompetence.

In other words, if a stockbroker goes bankrupt and your money or shares go missing, the compensation plan can reimburse you up to a specific amount. This is because your assets are supposed to be held in an account that is separate from the company's assets. Even if the brokerage firm collapses, your shares remain your property. If they cannot be clearly identified as yours, something has gone wrong.

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. You will not be entitled to anything if you have invested money via an unregulated brokerage that is operating illegally.

So, it is not enough to just know the local rules. You must also make sure that your broker is operating legally and is licensed and regulated to the extent required by law, to make sure you are protected.

You should also be aware that in many countries there are investments or financial activities that are legitimate but not covered by the regulations or the compensation scheme. One example is the transfer of foreign currencies into the UK.

The investor compensation systems across the world

The limits for some major financial centres are listed below. Please note that these are the rules that are applicable to investment firms - those for bank deposits are usually different.

  • UK Financial Services Compensation Scheme (FSCS) provides compensation of up to £85,000.
  • Singapore Exchange (SGX) Fidelity Fund: up to S$50,000 (only covers transactions on the Singapore Stock Exchange).
  • Hong Kong Investor Compensation Company: up to HK$150,000.
  • US Securities Investor Protection Corporation: up to $500,000.
  • Luxembourg Association for the Guarantee of Deposits: up to €20,000.
  • In the European Union, €20,000 is also the minimum compensation. However, some countries offer more and there are plans to increase this minimum.
  • In France, the FGDR (Deposit Guarantee and Resolution Fund) guarantees securities (shares and bonds) up to €70,000.

Beware of offshore operations

There is further complication that could affect traders who are unfamiliar with the facets of international relations. Not all territories governed by a European Economic Area (EEA) country are part of that country's financial regulatory system.

Note in particular that UK territories such as Jersey, Guernsey, Isle of Man and Gibraltar are popular tax havens and are home to some offshore stock brokerage firms (and forex brokers).

Gibraltar is a special case, since it joined the European Union under a 1974 UK treaty. Therefore, although the country is not covered by Luxembourg regulations, for example, it has implemented the relevant European Directive and would pay compensation of up to €20,000 under the Gibraltar Investor Compensation Scheme.

The Isle of Man has stepped up its existing bank deposit protection system after a large number of Kaupthing Singer & Friedlander Isle of Man depositors lost their savings following the collapse of Iceland's Kaupthing bank. Jersey and Guernsey have also introduced similar solutions.

But these plans offer no protection for investments other than funds - assets held with a brokerage firm based in those territories would therefore not be covered. This is an important point, as some of the low cost brokers who currently market their services to EU and UK traders are in fact based and regulated in the Isle of Man.

Comparison of stock brokers

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