The reason there is a difference between the FSCS limits for deposits and investments is that they are held in completely different ways.

When you put money into a bank it is no longer ring fenced as your money. It is moved onto the bank's balance sheet which allows them to then lend it to others. This is how the banks make money, but it does mean your money is exposed to the risk of the bank going bust.

With investments, however, the money is held under the client money rules which means that you retain full rights over the investments and they are ring fenced from the assets of the broker/unit trust provider/custodian. If they fail, their creditors have no call at all on the assets of their customers.

And the client money rules are tight. If you are feeling particularly concerned or bored, you can read the rules here, http://media.fsahandbook.info/pdf/CASS.pdf These are knows as the CASS rules and there are about 167 pages of them. Essentially they are all about putting sufficient controls in place to ensure that your broker knows exactly what all clients have and that they hold what they should, and that they reconcile the amounts regularly, and are subject to internal and external review of their processes and procedures.

Of course you may be thinking, "that's fine, but what happens if the broker goes bust, how do I get to my money?" And that is a sensible question. However, brokers should never go bust in the way that means they suddenly have to close up shop.

Brokers and other financial services companies are required to have sufficient capital to ensure that this never happens. They are also required to monitor their capital levels continually, and if they fall below a certain level they are required to notify the FSA. They will then either have to raise more capital, sell the company, or arrange for an orderly close. The capital requirements are such that a firm getting into trouble will have enough capital to conduct such an orderly winding up. In fact many firms are now being required to have "living wills" to show how they are prepared for such an eventuality.

If you want to read the rules on this, they are in the Prudential sourcebook for Banks, Building Societies and Investment Firms. These rules, known as BIPRU, make the CASS rules look simple. They stretch to 1021 pages.

Now of course you are thinking that it is all very well having these rules, but it is no good if a firm does not follow them. And that is true. But, under other sections of the rules (such as PRIN, SYSC and APER) firms and their senior management are personally liable for the activities of the firm and can be prosecuted and fined for failings in this area.

This is a rather hot topic for the FSA at the moment and they are conducting a lot of work in this area to ensure that firms are up to scratch, and they have fined a number of companies and individuals for failings. As far as I am aware, few if any clients have actually lost any money.

So what does this all mean? Well, in order for an investor to lose money, the firm would need to have been subject to a large fraud that went undetected for quite some time by internal staff, internal auditors and external auditors. This would have to be on such a scale that it pushed the firm into bankruptcy and that there was insufficient capital to repay. Many firms have additional insurance to cover this, but if the fraud was sufficient to take it past that, then there is a risk of loss.

But even here that generally doesn't happen. What tends to happen is that another firm buys the defrauded firm for essentially nothing and covers the liabilities. This helps reassure investors and therefore keeps the market moving.

So with all these controls, the government/FSCS have decided that the risk is less therefore the cover can be less.

You also need to remember that it is other firms that cover the cost of the FSCS. Last year Rathbones suddenly had to find £3.6m, Brewin Dolphin had to find £6m and Charles Stanley had to find £2.6m http://citywire.co.uk/wealth-manager/rathbones-faces-3-6-mil... and you can be pretty sure that over time this will have to come out of customers' pockets.




Akiking