In the modern, in my opinion overly complex, financial world there must by now be nearly as many investment risks as there are grains of sand on that now long forgotten Spanish beach where you spent your summer holiday. One of these is that your broker/wrapper/online provider goes belly up and takes your wealth with it because they failed to segregate your assets from their own through fraud, negligence or even good old fashioned incompetence. Here I am currently most exposed through my SIPP provider Youinvest, my ISA provider TD Direct, my trading account provider Hargreaves Lansdown and the large insurance company (the name of which I won’t mention as I could never recommend any element of their offering) who ‘looks after’ my defined contribution pension offered through my employer.
The same problem exists if the same fate befalls your fund manager. Here I'm personally seeing significant exposure through Vanguard, State Street Global Advisors (SSgA) and BlackRock (think iShares).
It’s a risk I've known about for some time but on a scale of risks that I’m conscious of I had it ranked fairly low, thus wasn't doing too much about, as I thought that:
News this week tells me that my assumptions were naive and just plain wrong with Barclays investment arm having owned up to having “£16.5bn of clients' assets "at risk" between November 2007 and January 2012”. This is neither a small amount of money nor a short period of time. It also happened to occur during the period when Barclays was in severe financial difficulties and had to be ‘bailed out’ by the state investment funds and royal families of Qatar and Abu Dhabi to the tune of £7.3 billion. It’s also not the only time with them having been penalised back in 2011 for “failing to ring-fence client money in one of its accounts for more than eight years”. Of course Barclays say that ‘it did not profit from the issue and no customers lost out’ but they would say that wouldn't they and given the timing it could have easily been a very different story.
Was it fraud, negligence or incompetence? I guess we’ll never know but given the amount, duration and timing I personally smell rotten fish. What also particularly concerns me is that the regulator, The Financial Conduct Authority (FCA), doesn't appear interested in deterring others from similar behaviour. Why do I say that? Well Barclays were given a £38 million fine for the infraction. The BBC calls this ‘a record’ but I call it 0.23% of the clients assets that could have disappeared into a puff of smoke. Given the damage this could have done to their customers futures and how much these guys skim off the top of our assets for me this is neither a deterrent nor a punishment that fits the crime.
The Financial Services Compensation Scheme (FSCS) covers investments to the tune of £50,000 per person per firm (for claims against firms declared in default from 1 January 2010) but of course it’s never as simple as that so we need to make sure we read all the small print. Monevator published an excellent post on this very topic back in December 2013 which is well worth a read.
£50,000 might sound like a lot but when you consider an investor trying to look after their own retirement financial destiny, who desires an ‘investment salary’ of £20,000, who believes that the State Pension will be means tested by the time they are eligible, who doesn't have any defined benefit pensions tucked away and who intends to drawdown from their own wealth at the rate of about 2.5%, will require invested wealth of about £800,000 before they can fully retire I'm sure it’s probable that it wouldn't come close to 100% compensating should one or more of their larger holdings blow up. I know it wouldn't 100% compensate me given my current holdings.
It looks like it’s time to start looking for ways to further diversify both my wrappers and fund managers over time...
As always DYOR.
The same problem exists if the same fate befalls your fund manager. Here I'm personally seeing significant exposure through Vanguard, State Street Global Advisors (SSgA) and BlackRock (think iShares).
It’s a risk I've known about for some time but on a scale of risks that I’m conscious of I had it ranked fairly low, thus wasn't doing too much about, as I thought that:
- The process of segregating your customers assets from your own really isn't very difficult so it should occur through negligence or incompetence very infrequently;
- Given its simplicity non-segregation would be easily and quickly identified by the firms accountants, compliance officers, auditors and/or regulator should it occur; and
- Non-segregated amounts, should they occur, would be relatively small in relation to total assets under management so result in only a relatively small loss given a large sum would be like an elephant standing in the room for those same accountants, compliance officers, auditors and/or regulators.
News this week tells me that my assumptions were naive and just plain wrong with Barclays investment arm having owned up to having “£16.5bn of clients' assets "at risk" between November 2007 and January 2012”. This is neither a small amount of money nor a short period of time. It also happened to occur during the period when Barclays was in severe financial difficulties and had to be ‘bailed out’ by the state investment funds and royal families of Qatar and Abu Dhabi to the tune of £7.3 billion. It’s also not the only time with them having been penalised back in 2011 for “failing to ring-fence client money in one of its accounts for more than eight years”. Of course Barclays say that ‘it did not profit from the issue and no customers lost out’ but they would say that wouldn't they and given the timing it could have easily been a very different story.
Was it fraud, negligence or incompetence? I guess we’ll never know but given the amount, duration and timing I personally smell rotten fish. What also particularly concerns me is that the regulator, The Financial Conduct Authority (FCA), doesn't appear interested in deterring others from similar behaviour. Why do I say that? Well Barclays were given a £38 million fine for the infraction. The BBC calls this ‘a record’ but I call it 0.23% of the clients assets that could have disappeared into a puff of smoke. Given the damage this could have done to their customers futures and how much these guys skim off the top of our assets for me this is neither a deterrent nor a punishment that fits the crime.
The Financial Services Compensation Scheme (FSCS) covers investments to the tune of £50,000 per person per firm (for claims against firms declared in default from 1 January 2010) but of course it’s never as simple as that so we need to make sure we read all the small print. Monevator published an excellent post on this very topic back in December 2013 which is well worth a read.
£50,000 might sound like a lot but when you consider an investor trying to look after their own retirement financial destiny, who desires an ‘investment salary’ of £20,000, who believes that the State Pension will be means tested by the time they are eligible, who doesn't have any defined benefit pensions tucked away and who intends to drawdown from their own wealth at the rate of about 2.5%, will require invested wealth of about £800,000 before they can fully retire I'm sure it’s probable that it wouldn't come close to 100% compensating should one or more of their larger holdings blow up. I know it wouldn't 100% compensate me given my current holdings.
It looks like it’s time to start looking for ways to further diversify both my wrappers and fund managers over time...
As always DYOR.
I fully agree. That Barclays story is a worrying example of how either negligence or fraud can easily put you at risk in a ‘seemingly’ trustworthy firm. There’s a lesson to all of us there.
ReplyDeleteAs part of my day job I look at counteparty risk, from a banks point of view. It’s ironic that Barclays will have been looking in great detail about the counterparty risk it is/was exposed to and regularly hedging out an excess exposure. It’s just a shame they (and I suspect others) didn’t impart the same courtesy to their clients counterparty risk.
As you’ve alluded, the only thing we (punters) an do is to diversify our counterparty risk by spreading our portfolios around several providers. Also I tend to research the financial statements of institutions that hold my funds as if I were going to invest in them.
I agree regarding 'impart the same courtesy to their clients counterparty risk'. In a publically listed company you should have 3 mouths to keep happy - shareholder, employees and customer. I think the priority order should be customer then employee then shareholder. Thinking that order then almost guarantees a happy shareholder. It seems Barclays aren't interested in any of them and prefer to just keep the Senior Execs and their bonuses happy.
DeleteInteresting idea to 'research the financial statements of institutions that hold my funds'. Doesn't that then restrict you to publically listed companies which would then exclude companies like Vanguard?
I use H &L and Barclays for UK holdings and Charles Schwab for USA shares. I specifically chose listed companies. I would never go with a private broker, who knows what's under the bonnet. I know we will be over the £50K limit but life just gets more complicated with more brokers, and if you have 20 brokers the chance you chose the one that went bust gets higher. BTW, the SEC guarantees the Charles Schwab account to $500K. I actually feel much safer with the Charles Schwab USA account because people have more of an affinity to the stock market over there instead of an obsession with property over here.
ReplyDeleteInteresting that the SEC guarantee is $500k. That's a lot higher than here. My only thought is that the T&C's on these things always seem incredibly long. In the event of a problem would they (or even would there be enough money) to pay out?
DeleteHere it is:
ReplyDelete- your holding is really with a chain custodians/subcustodians. Each of them may have an issue, but this is their core business, so this comes reputation. If you change your fund managers, it MAY impact the first party in the chain, but the new fund can use the same global/local custodian as the old one.
- the biggest issue in the industry is that banks are unwilling to invest into rebuilding backoffice applications. You may ask why? well, this is simple, this is frontoffice what makes money, settlement and record keeping are really just necessarily to maintain record and positions and from budget allocation side does not worth investing in new modern systems if the existing one which is 40-50 years old can handle it somehow. This is the decision on qualified higher level management which in some banks, especially in UK ones, are chosen on basis of not their qualification but ...how to say this politely... "closed cycle of friends".
This is likely what happened with Barcap. Just failure of management to invest in technology and/or operations to close some holes.
- Many funds outsource their custodian/asset servicing services to professional custodians. So, perhaps it makes sense to check what is the company providing this service to the fund manager to be certain.
K.
Re unwilling to invest in rebuilding back office apps. Interesting and given the current modern day short term thinking unfortunately not a surprise at all.
DeleteRe global/local custodians. Do you have any intimate knowledge in this area? For example do Vanguard actually own the shares/bonds/etc directly or do they use custodians.
Thanks for sharing K.
Re N2:
DeleteThis is public information and you can easily find it in company reports. There are actually just a few Global Custodians. So i found it after 2 min googling on vanguard website:
-------
Substantially all of the assets of the Company are held by J.P. Morgan Bank (Ireland) plc (the “Custodian”) to the Company. Bankruptcy or
insolvency of the Custodian may cause the Company’s rights with respect to securities and other positions held by the Custodian to be
delayed or limited.
The Company’s securities and other positions are segregated from the assets of either the Custodian or its agents. Thus in the event of
insolvency or bankruptcy of the Custodian, the Company’s assets are segregated from those of the Custodian or its agents. The Company,
will, however, be exposed to the credit risk of the Custodian, or any depository used by the Custodian, in relation to the Company’s cash
held by the Custodian. In the event of the insolvency or bankruptcy of the Custodian, the Company will be treated as a general creditor of the
Custodian in relation to cash holdings of the Company.
-------
Honestly, I would not be really worried about Global Custodians as this is core business of their. The issue with Barcap was most likely with market trading business where they have trading books.
K.
Many thanks for that K. I like the statement 'delayed or limited'. I read that as could be zero.
DeleteI must say I've now been educating myself about the world of personal finance on and off for 7 years but some days I still feel like I know absolutely nothing :-)
Cheers
RIT
Let me add this.
DeleteWhat is the meaning of "segregation"?
I suspect this is more an unofficial term to distinguish Contractual vs Beneficial Ownership of securities. Once securities are transferred to Custodian account, they are owned by the Fund, but instead they could be on the trading house Custodian account with other securities and other clients.
So, most likely the issue was that Barcap did not move the securities from Barcap Custodian Account to the client funds Custodian Account, therefore, ownership stayed Contractual rather than Beneficial for a number of years for those holdings. This is the risk as in case of bank failure Contact would not be owned, unlike holding with Custodian.
The practice is to move holding to dedicate client custodian accounts once settlement is done (likely on trading house accounts) or keep it there if the fund plans to trade again in the near future.
K.
Someone I know recently made an ISA transfer between two well known brokers. For around 3 months one of her funds continued to show on both the old and the new broker's online accounts with identical values. It makes you wonder if they ever reconcile the total value of shares they hold on the register with the sum of their individual client accounts. There could be millions in double counted assets floating around.
ReplyDeleteGood post. You are absolutely right that risks are higher than you'd think here. I have personally two experience of these issues:
ReplyDelete1) I am a client of Barclays Wealth. During the 2008-9 period I asked my 'personal banker' point blank whether such and such a holding was segregated from Barclays' balance sheet. I got a very worrying opaque look and a completely unclear answer. I still don't know whether this was banker incompetence (she is no longer with Barclays, but nor are most of the private bankers from that era) or evasive behaviour. Neither explanation was good. It is no surprise to me that they have been shown to have £16bn in an unclear place for 5 years. Fortunately for me, this hasn't cost me. It could have, as the following example makes clear....
2) .... I have also had a small sum with MF Global. Those guys who went down. And who had fraudulently comingled client funds with their own funds. My big lession here was that even with $0.01c out of every $1 'corrupted', the regulators/accountants/administrators will freeze *every $1*. I have, in theory, just received back all my funds whole - although cashing the cheque is another story - but for 2-3 years I was illiquid and out of funds. This is despite a) full client separation in theory (not in practice, as your post makes clear) and b) the fact that actually only a very small amount of money was fraudulently comingled by MF Global. Painful. A lesson to all of us.
So RIT is making a very very good point here and it is for this risk mainly that I continue to diversify my holdings across providers far more than is good for my free time. But as RIT points out once one is approaching the pension cap (£1.25m) one is well beyond the level that the compensation scheme covers you, and you really at that point need to remember the Equitable Life, MF Global, Icelandic banks, Cyprus, etc stories and make sure you spread your assets around.
Thank you RIT.
Interesting point.
ReplyDeleteI find it hard to quantify this one at all.
With volatility, we can look at historic volatility of our holdings or markets in general, obviously not a guarantee of future volatility, but a pretty good indicator? And diversify our holdings enough so that we are only left with systematic risk. (Or do some fancy maths, with suspect assumptions, if we please.)
We can try to design our personal holdings to hedge against inflation risk in some way, given it should be linked to interest rates or unit growth in some fashion.
We can have an idea of what regulation risk might mean to us if (when) the government decides to tinker with our pensions.
But my mind is blown when looking at counterparty risk for us as individuals. In my studies credit default or counterparty risk was almost always considered as an afterthought, especially if the counter party was AAA or AA rated. Suspect this is changing or has changed now. Maybe the best thing is to diversify across loads of providers, but then this becomes an administrative pain in the *ss and you may argue that if one provider is in trouble then it's all probably systematic across the whole market anyway. Stubborn thinking perhaps.
I've only really just started looking at my finances properly and this risk makes me want to bury my money instead of handing to, seemingly mental, providers. Like others say, is all we can do diversify and research and hope?
Fining banks is insufficient punishment. It will take directors in jail before they take notice. Former banker here.
ReplyDeleteI'm pondering holding some gold sovereigns at the Royal Mint. They boast that it's segregated by the Ministry of Defence!
ReplyDeletePeople regularly put all they own at risk when they leave the purchase price/sales proceeds of a property with their solicitor and assume that the funds are in a segregated client account, which it should be under Law Society rules, but if fraud intervenes you will be relying on various insurances. In the end you have to take some risk but it's a good question whether it is wise to have say 100% of one's assets with Vanguard. My " exposure" to them is getting pretty high.
ReplyDelete