How safe are ETFs for online investors?

bluefukurou

I'm currently researching which online broker to use for buying ETFs. I'm an expat that plans to return to the UK when I retire. I plan to buy and hold for the long term, so I'm talking about 25+ years.

However, I'm extremely cautious and when I started looking into where the ETFs are held and what control you have over them, I started coming across contradictory information regarding the ownership of the ETFs.

Some supposedly knowledgeable and reputable sites state that if a broker goes bust, the ETFs still belong to you and you have nothing to worry about. Others seem to suggest that you could have problems getting your money back because they are held in a nominee/omnibus account, but your name is not listed anywhere as owner, so fraudulent behaviour on the part of the broker could leave you out of pocket.

It also seems that many of the well known online brokers claim to have protection in their jurisdiction similar to the UK's FSCS, but when you look into the small print, they are often only for cash deposits, and have much less than the advertised figure or none at all for securities.

How risky is it to invest substantial amounts in ETFs with these companies?

talexuser

As I understand it the assets are held by a custodian to ringfence them. If the management firm goes bust, another should step in to take over the assets. If worried you should investigate the counterparties since ETFs can have multiple ones, which may spread risk or not, I don't see a lot of risk difference to holding individual shares where your broker might go bust or do some fraud. Perhaps more expert posters can explain it more fully?

Those ETFs domiciled in Ireland are not covered by the UK compensation scheme of £50k, and may be covered up to €20k, but by no means all are, depends on the fund.

Linton

The risk of loss of wealth held with a mainstream UK online broker by fraud is possibly as likely as being struck by lightning or dying in a plane crash. Difficult to say because, as far as I know it has never happened. So its theoretically possible but not something to worry about every day.


It is correct to say that brokers do not own your investments but merely have the right to manage them under your instructions. So if one went bust your investments could not be used to pay their debts. What is most likely to happen would be that the business would be sold to another broker and would carry on. It is much the same situation with funds (eg ETFs) and their managers. If you dont trust online brokers I find it difficult to understand why you would want to invest in ETFs. The banks are very different as they own any money you deposit with them and you merely own their promise to repay you on demand.


In the unlikely event there was fraud in a brokerage then the broker would cover you. In the very much more unlikely event that it was of a scale that caused the broker to go bust the FSCS would cover you up to £50K. Some of the brokers are major financial institutions. HL for example is in the FTSE100 and manages £90B of investments. II is smaller but still looks after £20B. They are all subject to Regulation.


If you have a very large investment pot it may be prudent to use more than one broker. This is not because of fraud but rather to protect you against any yemporary disruption of access to your money arising from IT failures or the sale of the business.

bluefukurou

Thanks for the replies. I was expecting those kinds of answers, which if I've interpreted them correctly are basically saying the risk is fairly minimal, all things considered, and can be mitigated by having investments with multiple brokers that are regulated correctly in the country they operate in.

As a non-resident, the firms I'm considering are the usual suspects for UK expats such as Strateo, Internaxx, Degiro, Swissquote, etc. They are all based in Luxembourg, Switzerland, Holland, etc. Interactive Brokers are also widely mentioned, though their US location seems to complicate tax issues if you have heirs.

Does anyone have experience with these firms? I'm looking to make minimal trades and therefore custody and inactivity fees are important for me. I'd be making large (for me ), but infrequent trades of around £5-10k two or three times a year.

dunstonh

However, I'm extremely cautious and when I started looking into where the ETFs are held and what control you have over them, I started coming across contradictory information regarding the ownership of the ETFs.

Broadly speaking, ETFs are considered higher risk than the closest equivalent UT/OEIC. Partly as ETFs can have different replication methods which need understanding. The other being that there is no FSCS protection on ETFs.

So, you tend to find most start on UT/OEICs and the majority of people stick with those. However, some may add in the odd ETF.

I'm looking to make minimal trades and therefore custody and inactivity fees are important for me.

ETFs can now cost more than UT/OEICs as well. So, on long term holds where you need to rebalance the portfolio, the annual charges may be similar but the trading charges on the ETF may nudge it over.

You would surely be rebalancing the portfolio?

talexuser

dunstonh wrote: »

The other being that there is no FSCS protection on ETFs

What is the distinction please, because e.g. the Vanguard site says you are covered up to 50k without any specific qualification that it does not cover ETFs. So if Vanguard goes bust you are covered but if an individual ETF goes bust (how?) you are not?

seacaitch

Linton wrote: »

Some of the brokers are major financial institutions. HL for example is in the FTSE100 and manages £90B of investments. II is smaller but still looks after £20B. They are all subject to Regulation.

I'd agree with much of your post, in particular the importance of regulation in protecting us, but as a point of order with regards to II (and not to pick on them especially other than you did specifically name them...) then a quick look at their last (2016) published accounts tells you that II is not really a "major financial institution" in terms of financial/balance sheet strength (although perhaps you weren't actually implying that and I've misunderstood?):

Group of companies' accounts made up to 30 June 2016

Metrics: Turnover 17.1M
Operating Loss: 1.7M
Group Retained Losses: 18.7M

NB the current picture will differ from this, but they're the latest published figures.

The reason I mention this is because you wrote:

Linton wrote: »

In the unlikely event there was fraud in a brokerage then the broker would cover you.

...which would require the broker to have sufficient balance sheet strength to do that, otherwise it would have to pursue other options such as seeking a buyer (that you also mention).

I'm not seeking to worry anyone or anything by pointing the above out; instead I'm simply showing the sort of thing that, wearing my risk manager's hat, I personally have given consideration to when arranging my affairs. As stated in another thread, I have a "safety systems engineer" mindset that I believe prudent but others might consider OTT

masonic

talexuser wrote: »

What is the distinction please, because e.g. the Vanguard site says you are covered up to 50k without any specific qualification that it does not cover ETFs. So if Vanguard goes bust you are covered but if an individual ETF goes bust (how?) you are not?

There are really only three ways you could receive a FSCS payout when investing in a collective investment fund:
1) Failure of ring-fencing of client assets
2) Administration costs charged to client assets
3) Fraud

You would not be covered against any of the above if investing in an ETF as it is treated as a direct equity investment and there is no protection available when corporate entities get into the troubles above. If you held a Vanguard ETF, which was subject to the above, then you'd have no protection.

If however, you were investing through the Vanguard platform and they failed to invest your money in the Vanguard ETF and instead made it disappear, or they went bust before investing it in the ETF, you'd have the FSCS protection for cash deposits to fall back on.

dunstonh

talexuser wrote: »

What is the distinction please, because e.g. the Vanguard site says you are covered up to 50k without any specific qualification that it does not cover ETFs. So if Vanguard goes bust you are covered but if an individual ETF goes bust (how?) you are not?

Have you got a link to where it refers to ETFs from Vanguard getting FSCS protection?

Vanguard UT/OEICs certainly have FSCS protection. Not the ETFs though.
Vanguard as a product provider (as in their internal product - ISA/GIA) gets FSCS protection. Not the investments within it though.

FSCS protection is not given to direct assets. Although packaged ETFs or ETFs bought under advice do get FSCS protection (albeit indirectly - a failure in advice rather than failure in the investment)

masonic

seacaitch wrote: »

Group of companies' accounts made up to 30 June 2016

Metrics: Turnover 17.1M
Operating Loss: 1.7M
Group Retained Losses: 18.7M

NB the current picture will differ from this, but they're the latest published figures.

The reason I mention this is because you wrote:

...which would require the broker to have sufficient balance sheet strength to do that, otherwise it would have to pursue other options such as seeking a buyer (that you also mention).

I'm not seeking to worry anyone or anything by pointing the above out; instead I'm simply showing the sort of thing that, wearing my risk manager's hat, I personally have given consideration to when arranging my affairs. As stated in another thread, I have a "safety systems engineer" mindset that I believe prudent but others might consider OTT

Yes, quite a few platforms are loss-making and seem to be sustained on a stream of fundraising in the hope they will become profitable.

But, the main point to note is that FSCS protection is available for properly authorised brokers, and would only be needed if they acted improperly (fraud etc) in the event they went into Administration without leaving sufficient provision for their investments under management to be wound down or taken over (in which case it may be available depending on the circumstances). The FCA requires all such companies to have wind-down plans and cash set aside to cover the costs of executing such plans. That doesn't make it completely safe, but reduces this risk.

seacaitch

masonic wrote: »

But, the main point to note is that FSCS protection is available for properly authorised brokers, and would only be needed if they acted improperly (fraud etc) in the event they went into Administration without leaving sufficient provision for their investments under management to be wound down or taken over (in which case it may be available depending on the circumstances). The FCA requires all such companies to have wind-down plans and cash set aside to cover the costs of executing such plans. That doesn't make it completely safe, but reduces this risk.

Agreed. My additional prudence is very much aimed at unlikely edge cases, plus a nod to balances above FSCS limits. I would not suggest otherwise.