In the context of a financial services firm going bust, Cherry Reynard looks at the important distinction between a bank and a fund group or platform - the latter two do not hold client assets
The financial crisis prompted a significant reappraisal of just what constitutes ‘safe' in financial services. Previously, few would have considered whether money held with a major institution, such as a high street bank, would disappear but the experience of Northern Rock forced a rethink. Since then, investors have been understandably cautious about how their money is held - and by whom.
These concerns, naturally, spread to fund management groups and raise questions that may trouble your clients. Is their money at risk if a fund manager goes bust? What happens if they are only exposed to a single fund group by way of a multi-manager arrangement? It is easy to see how they could see it as a considerable risk, no matter how apparently strong and well-resourced that manager may be.
Investors may also be concerned that, if they are only exposed to just one manager, they will receive less from the Financial Services Compensation scheme whereas, if money is spread across multiple groups, they would receive multiple sets of compensation in the event of those asset management companies going bust.
While at first glance rational, these concerns do not bear deeper scrutiny: While, in theory, any part of the chain could go bust - the platform, the multi-manager or the fund management group - in all these scenarios an investor's money would be protected. There is an important distinction here between a fund management firm and a bank - a bank holds the assets of its clients; platforms and fund management companies do not.
In all the latter cases, money is held on the investor's behalf by a custodian. Custodians are large, specialist institutions that focus solely on safeguarding a firm's or individual's financial assets. They do not engage in any traditional ‘banking' activities such as lending and operate under strict regulatory constraints. Clients' investments are ring-fenced from any failure by the platform or asset manager. If either falls into difficulty, the money is secure - the assets belong to the investor and creditors have no claim.
The Investment Management Association (IMA) points out the custodian must be independent from the manager of the authorised fund and that, in the UK, the custodian is not permitted to be part of the same corporate group as the manager. The trade body adds: "This separation of the management of the fund's assets from their ownership is the most fundamental element of investor protection provided by authorised funds."
Of course this does beg one final question - what happens if the custodian collapses? This is a remote scenario. Custodians are forced to hold significant levels of capital and endure high regulatory scrutiny to ensure customers are fully compensated in the event of any problems. Of course, they are also selected with considerable care by the asset management groups who use them.
It is, however, theoretically possible in the case of fraud but, in this scenario, holders would have recourse to the Financial Services Compensation Scheme. In all cases, the level of pay-out received from the scheme is the same - whether or not capital is spread among lots of different fund management groups or limited to just one.
Additional layer of protection
It is also worth noting that a tax wrapper offers an additional layer of protection. Insurance bond and pension wrappers are protected up to 90% of the full value of the pot. This is over and above any protection offered by the Financial Services Compensation Scheme.
There is also greater protection for investors being implemented by European policymakers - by way of the second Markets in Financial Instruments Directive (MiFID II) - and these rules are likely to remain in place after Brexit.
On this, the IMA says: "MiFID II is a very broad piece of legislation - regarding investor protection it covers: product governance, suitability of advice and due diligence, inducements (including research), remuneration regulations, as well as clarifications for independent advisers and meaningful disclosure to investors, including information on costs and charges." This should further enhance the protections available to investors.
The apparent insecurity of UK banks has left a legacy, but investment management is a very different industry and has long had checks and balances in place to safeguard assets in the event of a fund management group or platform getting into difficulties. Whether or not they hold all their assets in one place or choose to spread them around, investors are well-protected.
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