Assessing the Solvency and Financial Security of a Broker

The idea of a broker going to the wall would have sounded like a story from history until recently. But suddenly with the assets of some of the industry’s big names being frozen and clients at risk of suffering considerable losses, investors fear the worse and our industry reputation is at risk.

How can traders assess the solvency and financial security of a broker?

The lucrative potential rewards for successful financial traders are a significant lure to those with financial know-how and an entrepreneurial spirit. Barriers to entry are diminished by technology and the requisite knowledge that was once secret is now freely available.

However, every successful trade has to carry a corresponding loss and this level of risk may not be ideal for every diversified portfolio. A prospective trader needs to exercise caution, in particular with their choice of broking partner.

There are millions of people out there looking to invest money and don’t know who to avoid. On the other side of it you have these companies who break the rules so blatantly that they don’t care about regulation anyway. You have a massive void in the middle.

Safety of Clients Funds

The fierce economic storm that has been playing out globally hasn’t just been putting countries at risk, it is also affecting companies. Stockbrokers, financial institutions and banks are not immune. The Financial Conduct Authority has a huge challenge on its hands especially as events have shown that there is a need for increased and ongoing monitoring of the smaller players. While they may operate in a very different way to larger and longer-established brokers and banks, their failure carries risk for us all.

Over the past few years we have already seen the collapse of Pritchards Stockbrokers, MF Global UK and Worldspreads and this has had a domino effect throughout the sector, affecting clients and business partners who used white-labelled offerings from these providers. Despite this, we rarely see brokers marketing their services by their financial standing or solvency levels. This may well be because it doesn’t pull in the punters as effectively as claims about the lowest spreads or the highest number of product options. I suppose we can’t blame the brokers for that.

There has been a substantial increase over the last decade in the number of brokers offering highly margined products such as forex, CFDs, futures, and spread
betting. I’m certainly in favour of a competitive industry, but is it too easy for a broker to become established without having appropriate levels of capital,
systems and controls? Is there a level playing field with brokers who are based in jurisdictions that have perhaps differing standards and who passport into the UK?

However, the man on the street would do well to look a little closer at the companies with whom he deals, particularly given that the financial strength of some providers can be considerably different to others. It’s great for the industry and for consumer choice that we have seen so many new start-ups in the trading market in recent years, but it also means that investors must be careful. In other markets, since the collapse of Northern Rock and Lehman Brothers, organisations have been keen to highlight their solvency ratios. And yet, in the trading arena, investors are still too keen to put their buckets of cash with providers without doing even the basic level of due diligence.

Given the reputation that the UK has for high-quality regulation and consumer protection, you may assume that there are high barriers to starting up a UK brokerage. So most people are amazed to learn that you can establish your business and start taking client money from as little as €125,000. Some have questioned whether the relatively low minimum funding requirements have played a part in the spectacular and costly collapses which have attracted negative publicity both at home and abroad. And despite those left significantly out of pocket, free market campaigners argue that any limit increase could leave the man on the street with a shortage of choice, by preventing innovation and restricting competition.

An association gives a trade body an accreditation. It is something that the retail investor will look at very closely. It is a way of policing the community.

Regulation

• Consider where the broker is licensed and regulated, and understand the protection offered. In the UK the Financial Services Compensation Scheme (FSCS) protects the first £50,000 of a trader’s investment (subject to eligibility).
• Understand that the regulating country might not be the country they operate from, such as brokers who ‘passport in’ to the UK while being authorised elsewhere.
  Examine the broker’s license and understand what it allows them to offer.
• A broker who is licensed and regulated across several countries must comply with wider regulation and it follows that they are likely to be a safer partner.

A firm such as IG has to comply with the regulations imposed by the Financial Conduct Authority as well as the stringent group guidelines set by the different countries in which it operates.

Strict regulation is not an absolute guarantee of security and may not always stop the determined rogue.

TRADING PLATFORM:

• Of the 800 or so in use, MetaTrader 4 is generally the most respected.
• Security, flexibility, reporting and technical support are key areas to understand.
• At a time when clients want to trade anytime and anywhere, robust deliver of the service is as important as multichannel access.
• The IT infrastructure of your partner should be advanced and invested in to retain its cutting edge.

PRICING MODEL:

What should you expect?

• Transparent real time pricing structure
• Millisecond automated execution at best market price
• Low spreads
• Multi feed liquidity
• Available leverage and potential risks – are you guaranteed you’ll never pay a debit balance as a result of trading?

CLIENT MANAGEMENT:

The degree of time invested in you should help you determine whether your broker is after a fast buck or a lasting relationship.

Are you offered:

• A fully customised account manager tool?
• Access to exclusive research?
• A professional support team available when you need them, accessible via the channels you prefer?
• Are you offered marketing support?
• A top rate team?

What protection is offered in the UK?

The Financial Services Compensation Scheme (FSCS) is the UK’s statutory compensator of last resort for customers who have lost money through their dealings with regulated financial services companies. FSCS may compensate individual retail clients and small businesses for financial loss according to rules set by the Financial Conduct Authority (FCA). The compensation limit for a client of an investment firm such as IG is £50,000.

Consumers placing their money with FCA-regulated firms are protected by the Financial Services Compensation Scheme (FSCS) up to the value of £50,000 in the UK.

Some jurisdictions have moved to limit the level of margin or leverage available to clients such as Japan, the US and Singapore. European regulators have not indicted that they will follow suit as yet, but the FX community will monitor developments closely.