Choosing a Broker – Safety of Funds

There’s one aspect to choosing a broker that often gets overlooked which is safety of funds. Sadly, when you place your money with a broker your money is at risk from the broker going bust. Now, you may think that this a very remote possibility and of course it is but during the 20 odd years that I’ve been trading (very much on and off) I’ve had two brokerage accounts go bust on me so it does happen. You only have to look at the “Francageddon” incident to see what can happen in extreme circumstances and quite a few brokers went bust when the Swiss Central Bank suddenly pulled the plug on their EURCHF line-in-the-sand that they’d been supporting for quite some time. The thing that you have to remember is that a broker takes on the liabilities of its clients so if a few clients get into serious trouble and go bust then the broker is suddenly dumped with those losses. Sometimes it’s a rogue trader who racks up huge losses and keeps doubling down to try and make it back (à là Nick Leeson). If this person happens to be trading with your broker and they don’t spot it then again the broker can go under. Now of course you’d expect that all brokers would have proper risk management in place to spot all this but sadly it does still happen. All scary stuff!

How safe is your money with your broker?

Fortunately, here in the UK we have the Financial Conduct Authority (FCA) who oversee financial institutions. They have minimum capital adequacy regulations (basically each broker much have sufficient funds to cover such contingencies) and there is a compensation scheme which means that you’ll get back the first £75k or so of your money should they go bust. This is a very re-assuring thing for UK investors and which leads me on to my general rule when choosing a broker that you should choose someone in a good jurisdiction where there’s proper regulation and a reasonable chance of getting your money back should they go bust. I wouldn’t personally invest in some small off-shore brokerage company in a country that I’ve not even heard of and quite frankly you’re asking for trouble if you do this.

There’s one more thing to consider, namely that some brokers are down-right dishonest. I’ve heard of one case of an off-shore broker that, when clients try to withdraw their money, they suddenly decide retrospectively to adjust all their fills, slipping each trade by a few pips on every trade they’ve done so that suddenly all the profit that was sitting in their account has vanished. All completely illegal of course but whether you can do anything about it depends on whether they’re regulated at all. Again, it’s worth looking at the broker’s business model: if they’re an ECN then they’re not going to do something like this as they don’t care about the trading as long as they get their commission. A bucket-shop type of market maker on the other hand is going to have more of an interest in you doing poorly. Of course such blatant dishonesty isn’t a viable long-term business model and word does get around but you should be wary of reviews in public forums as they can be posted by the brokers themselves. A good sign of this is a broker review from a new member who’s only done one post – very dodgy! 
So, in conclusion, the safety of your funds in the worst case scenario is an important part of choosing your broker.