Broker Bankruptcy: What happens to your investments?

Mr. The Poor Swiss | Updated: | Investing
Broker Bankruptcy: What happens to your investments?

(Disclosure: Some of the links below may be affiliate links)

When you plan on living on your investments, you need to consider the safety of these investments. Some of them will be in your retirement accounts. But the bulk of your investments will be in your broker account.

So, what happens if your broker goes bankrupt? Are we going to lose everything?

In this article, we will see in detail what happens to our securities if a broker goes bankrupt.

Broker Bankruptcy

An online broker (or a bank offering brokerage services) can go bankrupt like any other company. In that case, it is important to know what would happen to our assets. It is especially important for people than want to retire based on these assets. If these people suddenly lost everything, they may be in big trouble.

Online brokers are regulated. Now, the regulations will depend on where the broker is from. So, how well you are protected will depend on where your broker is located.

In this article, I am going to look at some of the regulations and protections in case of broker bankruptcy.

Swiss Brokers

Let’s start to see what would happen in the case of a Swiss Broker Bankruptcy.

In Switzerland, Swiss Banks are registered with FINMA. FINMA is the supervisory authority. If you have cash in your broker account, it will be protected by Swiss Deposit Insurance.

For securities, FINMA forces banks to use asset segregation. It means that the bank assets are held entirely separate from the client’s assets. The bank only acts as a custodian. This segregation will be done for most assets like stocks, ETFs, and bonds. But it will not be done by investments directly from the bank such as structured products.

And if your Swiss Broker is not a registered bank, it will use a licensed custodian bank to hold these assets in your name. In that case, it is more complicated to have the custodian bank go bankrupt rather than the broker goes bankrupt since the broker holds no assets.

Interactive Brokers

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Interactive Brokers

Interactive Brokers is an outstanding broker, with extremely affordable fees! Trade U.S. security for as little as 0.5 USD!

Interactive Brokers is available to Swiss Investors but is not a Swiss Broker. As such, it will have different regulations. With Interactive Brokers, it is a bit complicated because they have several entities in different countries. For instance, the main entity is IB US, which is regulated by the United States.

As a Swiss Investor, we invest with Interactive Brokers UK. These accounts are regulated by the United Kingdom’s regulatory services. But we have an extra layer of security provided by the Securities Investor Protection Corporation (SIPC) from the United States. It is due to the way IB is organized.

With SIPC, you have protection for up to 500K USD if the broker goes bankrupt. There is a limit for 250K of cash on that. So, you have excellent protection, currently the best available.

On top of that, Interactive Brokers also segregate assets from clients. It means that all your securities are held in an account in your name, in a custodian entity.

Due to Brexit, many accounts are now moved from IB UK to other IB entities in the European Union, such as Luxembourg (IB LUX). So, if your account is moved from the IB UK entity to an IB EU entity, you will now be protected like any other EU brokers. It really sucks because we are going to lose the extra SIPC protection. You can look at the next section to see what that means.

For more information, I have a full review of IB.

DEGIRO

DEGIRO is a broker from the Netherlands. In August 2020, DEGIRO has been bought by Flatex Bank AG. It is regulated by the Authority for the Financial Markets (AFM) and the Dutch Central Bank (DCB). In some countries where it operates, it also has some extra regulators, for instance, in the UK.

DEGIRO has the standard European layer of protection. With this protection, 100’000 EUR of cash and 20’000 EUR of assets are insured in case of a broker bankruptcy.

Once again, DEGIRO assets are held separately (asset segregation) from the client’s assets. A different legal entity (SPV) is used for that. So, again, if DEGIRO bankrupts, your shares will be held in the custodian legal entity.

For more info, read my review of DEGIRO.

Asset Segregation

As you can see, the main protection against broker bankruptcy is asset segregation. Your assets should be held separately from the broker’s assets themselves.

If the broker goes bankrupt, the segregated assets cannot be claimed by the creditors of the failed broker. After the bankruptcy has settled, they will need to find another broker to handle the assets. Once this is done, you will have access to your shares again.

We do not really have good examples of this happening to know how well this will work in practice. I am expecting that this process will last a long time. I would not be surprised if it would take more than a year to get back access to the shares.

Keep in mind that asset segregation does not mean that assets are held in your name. Most brokers will pool all the securities in a big account (called omnibus or nominee accounts generally). Of course, there is still an indication as to which customers have which share linked to this account. But for cost reasons, most brokers will not have individual custodian accounts.

Asset Segregation is a great tool for normal bankruptcies. But, in the case of fraud or possible negligence, this asset segregation could have been compromised. In that case, the process can be extremely complicated. And at least part of the assets would likely be lost.

Securities Lending

When a broker lends your shares to another investor, the share is not entirely yours during the loan duration. So, what happens if the broker bankrupts during this time?

For instance, securities lending is something DEGIRO is doing by default with its DEGIRO Basic account. When they lend your shares, they borrow your securities from the legal entity. Now, if DEGIRO goes bankrupt, the borrower of the loan still owes you that loan.

But there is still the extra risk of the borrower going bankrupt too. And investors borrowing shares are more likely to go bankrupt than others.

There is a definite extra risk in case of a broker bankruptcy if this broker uses securities lending. It is not a huge risk, but it will make it more complicated to recover all your shares.

Direct Registration

Many people think that all their shares are directly registered in their names. But in most cases, this is wrong.

As mentioned before, your assets are generally held in big omnibus accounts. And only the segregation legal entity is aware of which investor holds which shares.

There are some systems by which you could register shares in your name.

For instance, in the United States, the Direct Registration System (DRS) can do just that. It is like an official registration system for share ownership. And with U.S. brokers, you can arrange your trades to be registered in this system. That way, your shares are really held in your name.

Doing so will help in case of broker bankruptcy since then your claim is directly with the company of the share and not the intermediary (the broker).

In Switzerland, we have a system of share registers. With some brokers, you can register the ownership of your shares in a share register. These are public registers for publicly-traded companies. It is a very different system since the share will still be held by the broker. But you will have a public official trace of the shares.

Now, this system will make it more complicated to buy and sell shares. And there is no unified share register for all stock exchanges. So, the rules will be different from country to country.

I do not think it is necessary or even practical to do that for all your shares to protect against broker bankruptcy.

Protect against Broker Bankruptcy

What can you do to protect yourself against broker bankruptcy?

The best protection against broker bankruptcy is to use a well-established and reputable broker. For me, Interactive Brokers is excellent in that regard. It was established more than 40 years ago and has an excellent reputation.

And you need to make sure to use a broker that enforces asset segregation. It is essential. Asset Segregation is the best protection against broker bankruptcy. Any broker that does not segregate assets should not be considered safe.

If you really want an extra layer of security, the only thing you can do is have several broker accounts. For instance, you could have some of your investments with Interactive Brokers and some Investments with a large Swiss Broker. In that case, if one of them goes bankrupt, you can still live from your investments in the second broker account.

However, having two broker accounts will make your investing significantly more complicated. And this will mean that you will not only use the best broker in Switzerland but a second one. But this could be worth the cost if it helps you sleep at night.

Conclusion

The main protection against broker bankruptcy is asset segregation. Assets of the clients of the broker are not held in the same entity as the assets of the broker itself.

So, in case of the broker going bankrupt, the creditors of the bankrupt will not be able to claim the assets of the client. This is an essential protection.

This protection is enforced for Swiss Brokers, Interactive Brokers, and DEGIRO.  If you use another broker, you should definitely verify that your assets are segregated. I would not recommend using a broker where this is not the case.

In this article, I have talked mostly about broker bankruptcy. But there is another risk in the case of broker fraud or negligence. In that, asset segregation may not work since the segregation could have been compromised. We have seen that there are some levels of protection for these assets (20K EUR for European brokers, for instance), but it is unlikely to be enough.

I am going to try to talk about broker fraud and protection against it in a future article.

Are you afraid of broker bankruptcy? How do you protect against it?

Mr. The Poor Swiss is the author behind thepoorswiss.com. In 2017, he realized that he was falling into the trap of lifestyle inflation. He decided to cut on his expenses and increase his income. This blog is relating his story and findings. In 2019, he is saving more than 50% of his income. He made it a goal to reach Financial Independence. You can send Mr. The Poor Swiss a message here.

22 thoughts on “Broker Bankruptcy: What happens to your investments?”

  1. Segregation is not the best way to protect in case of bankruptcy. Your Swiss bank account is also segregated but only 100k is guarantee because cash sits on the balance sheet of the bank and the bank use it to make money for them through loans.
    What about broker vs Swiss banks ? Easy to very, let’s open UBS and IB audited 2020 annual reports. It is available publicly https://www.ubs.com/global/en/investor-relations/financial-information/annual-reporting.html and https://investors.interactivebrokers.com/ir/main.php.
    For UBS report on page 8, we can see that the 4T UBS of invested client assets does not appear on their balance sheet of 1T USD.
    For IB report on page 63 we can see that the 15,903M USD(client cash) + 27,821M USD(client securities) DOES appear on the 95,679M USD IB balance sheet.

    Segregation just mean that asset are hold for the customer and cannot be used for daily operation such as paying their costs and salaries, it does not mean that they are not on their balance sheet and that they cannot make money for them. Moreover we can see in IB annual report page 64 that half of IB revenue is made through interest spread using customer asset. They are allowed to invest in low risk investments such as government bonds, overnight repo, fund sweeping …

    IB is not a bank as stated in one the comment, IB gives Reg.T margin account, banks in US are not allowed to give Reg.T loans, they can give Reg.U loans and Lombard loan in Switzerland.

    In case of bankruptcy, the whole balance sheet in considered segregated assets as well, following debtor priority. Above the insurance level, the broker client is just a standard debtor, no guarantee to get back fund above that. That’s why of a reason we pay custody fee at UBS and not at IB, there is no free lunch in wall street.

    Every investor should read and understand financial reports of companies they use and invest in. Otherwise it is like buying a envelope with money in it at whatever price available without looking how much money is inside the envelop.

    IB is great for many thing, but not for holding big amount of securities over long term

    More info about this can be found on this white-paper https://www.privatebank.citibank.com/newcpb-media/media/documents/insights/CustodyWP_web.pdf

    1. thank you, very interesting.

      you wrote „IB is great for many thing, but not for holding big amount of securities over long term“

      what is your recommendation for holding big amounts (> 100k) of securities over a long term (>10 years)?

  2. Hi Mr. ThePoorSwiss,
    Thank you for the very informative article!
    If the broker uses asset segregation, then is it a risk if the custodian bank goes bankrupt?
    Do you know what is the custodian bank when I open Interactive Brokers account in Switzerland?

    1. Hi Z,

      Normally, it’s not at risk if the custodian bank bankrupts since all the accounts in the custodian bank will be segregated from the assets of the bank itself.
      I believe that IB is a licensed bank in the United States, to they are their own custodian bank. This may be different in other countries.

  3. Dear Mr. Poor Swiss,
    First, thank you so much for your blog; it really helps me a lot!
    I have a question:
    You said “With SIPC, you have protection for up to 500K USD if the broker goes bankrupt. There is a limit for 250K of cash on that. So, you have excellent protection, currently the best available.”

    I though that in case of bankrupcy (IB UK), only what is in cash (CHF) is at risk (not my ETFs) and therefore I do not understand why there is this distinction of 500k and 250k. Could you explaine please?

    1. Hi Ranim,

      I am not entirely sure, to be honest. My understanding is that customer assets should be safe with IB. So, SIPC should not matter much unless they do something at IB (break asset segregation) that will break this protection. In that case, SIPC would intervene for up to 250K of securities.
      But that’s only my understanding.

  4. Hi Mr TPS, we are now in February 2021, I was forced to move as CEE customer from IB UK to Hungarian IB entity, would you please tell me to which entity your account moved? And do you know which entity is IB using for newly opened accounts for Swiss residents? Thank you very much. Wish you good trading and investing. Marek

  5. Very good article, though to be honest I still am somewhat confused about the 20K insurance of Degiro. Is it basically an insurance in case they go bankrupt and the entity actually holding the assets are not able to find a new broker?

    Regarding securities lending I also wonder how much of a risk it is (or isn’t) with ETFs. How popular is it to borrow ETF shares? I personally see it as a very minimal risk.

    1. Hi Yora,

      It would be helpful if DEGIRO actually does not do segregation properly and bankrupts, in which case some assets would be at risk. It’s not great protection, but it’s better than nothing.

      For ETF, it’s a pretty minimal risk. It would be risky when both DEGIRO and the borrower defaults at the same time. This could happen, but then this would only happen to the shares that are currently being lent.
      Most ETFs are not being borrowed that much, but for some big popular Vanguard ETFs, there is some borrowing going on. I do not know how to find statistics on that though.

      Thanks for stopping by!

  6. This is a very good point and an important one to consider.
    So what I understand correctly is that by using IB, we are protected up to 500k. but if IB UK is moved to IB EU, then the users are not under SIPA and will have much protection value, right?

    1. Hi Yasi,

      Yes, we will lose SIPC protection which is a good advantage of IB. Our protection will be reduced from 500K to 20K.
      We still have not moved, but it’s concerning.

      Thanks for stopping by!

  7. Can one transfer HK$ stocks to one of these two brokers you mentioned?
    What is the difference between Firstrade and Interactive Brokers as both are US firms.? Thanks, loretta

    1. Hi,

      I guess you can transfer HK stocks, but I have never verified this, you will have to check the docs of both brokers.
      I have never done full research on FirstTrade, but apparently, you can only wire USD for free to FT, so it will only be good if you have USD and not CHF. The rest looks similar.

      Thanks for stopping by!

  8. Hello,

    what do you think about eToro? For <100K amounts and mid-long term investments looks as interesting option from cost point of view? Combined with Revolute it can bring yearly costs almost down to zero.

    Thank you

    1. Hi Vazgen,

      For a Swiss investor, eToro is pretty bad because you will have to pay to deposit CHF on their account. They are also quite bad at currency conversions.
      Revolut could help, but then you will have to trust Revolut with large amounts of money.
      I am also not sure they are still offering access to U.S. ETFs to Swiss investors.
      For me, it’s just not convenient. Even below 100K, I would still go with IB and pay the 120 CHF in fees per year.

      Thanks for stopping by!

      1. Would you also be of the same opinion wrt Degiro vs IB? I signed up with Degiro due to the fees for sub 100k accounts. Seems like a no brainer. Curious to hear your opinion.

        Thanks

        1. Hi Daniel,

          I am not sure I understand the question. My current opinion on DEGIRO vs IB is to go with IB unless you are going to invest small amounts of money (<10K). If you are going to invest seriously, I recommend IB because it gives access to U.S. ETFs. And moving broker is a pain, so if you ever plan to reach 100K and move to IB, I recommend starting with IB directly.

    1. Hi mikey,

      No, not necessarily. As mentioned in the article, the stocks and ETFs are not in the balance sheets of the broker itself, they are segregated in (generally) omnibus accounts. In case of bankruptcy, these accounts will be handled to another broker. It may take a while, but unless DEGIRO did fraud (or mistakes), this money should be safe in case of bankruptcy.

      Thanks for stopping by!

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