What happens if a fund or platform fails

The protections available to investors are frequently misunderstood, in both directions — people assume protection that does not exist and overlook protection that does.

The fundamental distinction

Which resolves most confusion.

Protection schemes cover losses arising from the failure of an authorised firm.

They do not cover investment losses arising from markets falling, which is the risk you are deliberately taking.

Which means a fund halving in value is not a compensation event, and a platform going into administration with a shortfall in client assets may be.

Client asset segregation

The first line of protection.

Regulated firms are generally required to hold client assets separately from their own, in accounts designated as client money or client assets.

Which means that if the firm fails, those assets are not available to its creditors and should be returned to clients.

In practice, administrations have involved delays, costs deducted from client assets, and occasionally shortfalls arising from poor record-keeping.

Which is where compensation schemes then apply.

Compensation schemes

What they cover.

Most jurisdictions operate a scheme compensating clients of failed authorised firms up to a limit.

Coverage typically includes shortfalls in client assets, costs of distribution, and losses from bad advice or misrepresentation by an authorised firm.

Limits vary by jurisdiction and by product type, and deposits are typically covered by a separate scheme with a different limit.

The critical condition is that the firm must be authorised — which is why checking the regulator's register before dealing with anyone is the single most important protection.

Fund structure

Why fund failure is different.

A fund is generally a separate legal entity with its assets held by an independent depositary or custodian.

Which means the fund manager failing does not mean the fund's assets are lost — another manager can take over, or the fund can be wound up and proceeds returned.

The risks that remain: fraud, which segregation is designed to prevent and has occasionally failed to; and the fund's investments themselves falling in value, which is not a protection matter.

Fund suspensions

A more common event than failure.

Funds holding illiquid assets have suspended dealing during stress, meaning investors cannot access their money for months.

This is not a failure and produces the practical effect of being unable to sell.

Which is a liquidity risk rather than a credit risk, and which compensation schemes do not address.

Regulators in several jurisdictions have introduced or consulted on notice periods and liquidity management tools in response.

Synthetic products

Where additional counterparty risk exists.

Synthetic exchange-traded funds use derivatives with a counterparty, which introduces the risk that the counterparty fails.

Collateral arrangements mitigate this and do not eliminate it.

Exchange-traded notes are debt obligations of the issuer rather than funds holding assets, which means the issuer's failure is a direct risk to the holder.

Which is a meaningful distinction and one that the similar names obscure.

Practical protections

What to actually do.

Check that every firm you deal with is authorised, on the regulator's own register.

Understand which compensation scheme applies and what its limit is.

Consider spreading holdings across more than one platform if the amounts substantially exceed compensation limits, though the practical risk of client asset shortfall is low.

Prefer physically replicating funds over synthetic ones where equivalent.

Avoid unregulated investments, which are outside all of this.

Keep your own records of holdings, since administrations depend on records.

And be aware that deposits held on investment platforms may be covered by a different scheme, or by none, depending on how they are held.

The unregulated problem

Where losses are unrecoverable.

Mini-bonds, unregulated collective schemes, cryptocurrency and various alternative investments fall outside compensation schemes entirely.

Which has produced substantial consumer losses in several markets, with no recourse.

Marketing frequently implies protection that does not exist, and regulators have taken enforcement action over this.

The check is simple: is the firm authorised, and is this specific product covered?

Both answers are available from the regulator.

What has actually happened

Historically.

Platform and broker failures in developed markets have generally resulted in client assets being returned, with delays and some costs.

Fund suspensions have trapped investors for months.

Failures involving fraud have produced losses partly covered by compensation schemes.

And unregulated products have produced total losses with no recovery.

Which is a reasonable guide to where the risks actually are.

General information only, not investment advice. Check firms on your national regulator's register and confirm what protection applies. Consult a regulated financial adviser.