Who gets compensated – and who doesn’t – when investors lose out
There is no apparent logic to the compensation available to people when investments go wrong
Large depositors were hit in Cyprus and European leaders have since agreed that large-scale depositors should bear part of the burden in any future bank failures under a tighter banking union
Investors who have lost money through fraud or negligence often assume wrongly that they may receive compensation. Others fail to claim compensation when they should.
There is no apparent logic. Some investors are lucky while others aren’t. For instance, foreign hedge funds that held bonds in the troubled Anglo Irish Bank were fully compensated; Irish credit unions on the other hand, as bondholders of the same institution, suffered heavily.
Investors with money on deposit, worried about the health of Irish banks can take some comfort from the Deposit Guarantee Scheme operated by the Central Bank.
In essence, if you have a deposit with a bank or credit union that fails, the Central Bank will compensate you. The upper limit is €100,000 per person per institution – and not per account – and is normally paid within 20 working days. The scheme is open to Irish residents and also residents abroad who have placed money with an Irish bank.
This, in theory at least, is one of the reasons why Irish banks were rescued on that famous night in September 2008.
Bondholders, on the other hand, are not protected which is why many economists have backed the call to “burn the bondholders”.
In Cyprus earlier this year, an attempt was made to override the deposit guarantee by forcing small deposit holders to share some of the losses its banks suffered. However, European Central Bank president Mario Draghi said this was a mistake and affirmed that the deposit protection scheme is likely to remain across Europe.
He added that “depositors with guarantees should be sacrosanct, but that it was best not to touch any depositors if possible”. You have a pecking order, and ideally insured depositors should be the very last category to be touched.
However, large depositors were hit in Cyprus – those over the threshold of the guarantee – and European leaders have since agreed that large-scale depositors should bear part of the burden in any future bank failures under a proposed tighter banking union.
For investors with larger amounts of money, An Post offers State saving products where there is no upper limit to the level of protection – beyond obviously the viability of the State itself against default on sovereign debt.
There is also a government Eligible Liabilities Guarantee (ELG) scheme which protects depositors who have more than €100,000 in a fixed-term deposit with a bank or building society. However, you must have deposited the money before March 28th last.
What happens if a stockbroker goes bankrupt?
There is a special compensation scheme where you have money invested in an authorised firm that the Central Bank has decided is not able to repay investors, which is administered through the Investor Compensation Company (ICCL).
The products covered include quoted shares, investment trusts, life and non-life insurance policies, tracker bonds and derivatives such as futures and options.
You can make a claim after the firm has gone into liquidation and remaining assets are distributed to investors. The compensation scheme then covers any shortfall up to certain limits.
Occasionally, foreign companies operate a branch or agency in Ireland. Under EU rules, an Irish resident is permitted to make a claim from the country where the financial institution or stockbroker is regulated.
The ICCL was set up to give private investors a way to claim compensation without the need for expensive legal action. It is funded by contributions from authorised or registered investment firms that are members of the scheme. Investors receive 90 per cent of what they lost, subject to a maximum of €20,000.
Insurance compensation fund
If you have taken out insurance protection with a company that has subsequently failed, the High Court administers a special insurance compensation fund.
First you must contact the company and if there is a shortfall in the payment you should receive, the fund will make up the difference.
Employees on defined benefit schemes (where the employer promises a yearly payment after retirement) are often worried that their employers may not have enough money to meet the pension promise, or may not even exist a few years from now.
For investors organising their own pension, there is the very real risk that pension salesmen will exploit the complexities of this area by offering an unsuitable pension package laced with hidden fees.
The Irish Pension Board was set up to regulate the sector and protect pensioners. All defined benefit schemes must check every year whether they are meeting their funding obligations, ie putting enough money aside to meet promises to retired, serving and former employees. If the pension actuary decides they are not, the pension trustees must submit a funding proposal.
From 2016 onwards, pension schemes will also have to put aside additional cash, known as a risk reserve, to deal with instances where pension funds could lose money by holding risky assets.
There is, however, a fear that too much regulation is forcing companies to close down their pension scheme.
To overcome customer confusion for those organising their own pension, pensionsboard.ie provides independent guidance on planning for pensions, the various options available and details of how fees are charged.
Surprisingly, for shareholders who invest directly with companies, the level of protection is quite limited. Understandably, shareholders should not be protected where, because of market conditions a business is forced to close. Fraud, however, is different.
Supposedly, shareholders are protected under company law and the listing rules of the Irish Stock Exchange in the case of publicly-listed businesses. However, these offer limited (if any) protection.
Shareholders defrauded by their directors must pay a lawyer to take legal action. Many sensible investors realise that, because of the complexity, this is in all likelihood a case of throwing good money after bad.
Cormac Butler is the author of Accounting for Financial Instruments and has led training seminars for bank regulators and investors on financial risk. He has traded equities and options