It is interesting how times change and how people’s biggest fears at one point in time fall into insignificance over time.
6/7 years ago here in Prosperous Financial almost all new investment clients would ask us "how safe is my money" or "what if the investment firm runs away with my money." They were concerned about fraudulent behaviour or the investment houses failing, not with markets collapsing.
In more recent times clients seem less worried about this, from memory I think we have been asked twice this year "what if fraud occurs in the investment house" or some such question.
Our "feeling" is backed up by some research carried out by Lloyd Insurance Broker Robertson Lowe who carried out research in 2013 and again in 2016 asking the question “How confident or not would you be that legislation and regulatory supervision provide adequate protection against the financial failure of investment firms or stockbrokerages in Ireland?”
- 2013: 48% would be “very” or “fairly” confident
- 2016: 70% would be “very” or “fairly” confident
In just 3 years people’s confidence has risen quite dramatically.
But do investors have anything to fear and what are they already covered by?
If you are invested in a deposit account in an Irish regulated bank you are covered for €100,000. But if you move away from deposit accounts and invest with life assurance companies, stock brokers or investment houses the compensation schemes are different.
But before we look at that lets consider the difference between a bank and a life company/pension provider/investment house. When you put money into a bank account the bank borrow money from other banks on the strength of your deposit and give the money out in the form or mortgages and loans to other customers.
If you put €100,000 into a deposit account the bank goes to the market and borrows a further €150,000 on the strength of your money and then comes to me and gives me a mortgage of €250,000 to buy a new house.
If everybody walked into the bank today looking for all their money back the bank would have to chase me to get me to pay the mortgage back in full to repay what they owe you. If enough people do it, this is what is called a run on a bank.
Between 1933 and 1944 President Roosevelt carried out 30 fireside chats where he addressed the nation over the radio. At one point the banks were in crisis, so many people were worried about the banks and there was a “run” on the banks. The banks couldn’t cope with the volume of work and so one Sunday evening the President announced that all banks would be closed the following day, Monday. This was the first ever Bank Holiday. The idea being that by Tuesday the banks would have caught up with their paperwork.
So, a bank uses your money to borrow more money to give it to other customers. What does and investment house of pension provider do? The opposite.
When you give money to a big life company or investment house they don’t borrow money on the strength of it. Instead they back it up with reserves. If everybody went into an investment house today looking for their money the investment house would not need to call in the loans of other customers and, barring the paperwork, everybody would get the underlying value of their investment back.
But what if through fraud or some other reason an investment house or pension provider couldn’t give your money back. That’s when other protections kick in.
Investment houses are not covered by the deposit guarantee scheme of €100,000. Most however are instead covered by the ICCL or the Investor Compensation Company Ltd.
In the event of an investment company fails to repay investors, typically due to fraud, and provided the liquidator deems the case to qualify, the scheme pays investors back 90% of their investment subject to a maximum of €20,000.
The ICCL does not cover things like poor investment performance, or bad advice which would more likely be a matter for the professional indemnity providers cover.
All this assumes the investment house is covered by the ICCL. Some big companies operating here such as Aviva, Royal London and Standard Life are covered under the UK scheme which provides protection of 90% with no upper limit. However, you would expect post Brexit they will revert to the Irish scheme.
Beyond that some other measures can kick in, for example the IBA (Irish Brokers Association which is soon to become Brokers Ireland) have an additional scheme which provides cover for up to 5 times as much as the ICCL.
There is also a new insurance product on the market now which offers investors the opportunity to protect themselves for a premium. The individual pays a premium each year and can get up to €250,000 worth of cover on top of the ICCL cover.
What I find most intriguing about this new product is that the product providers believe there is a market for it. The research and our experience has shown that most people won’t go looking for this product.
Investment houses aren’t going to take it out on themselves because it would be like announcing “we won’t commit fraud, but if we do, we have you covered.”
I am interested to see what the market is like for this product. If 70% of investors are “confident” the regulator has got their back, it is fair to say 30% are not, for those 30% of people maybe this product will help them sleep at night. I will admit that the people who are asking the questions around fraud prevention today are genuinely concerned about it. It will be interesting to see if this product eases people’s concerns.