Page 1 of 2 Most retail investors use an investment dealer or broker to invest. Any investor should realize that the collapse (very unlikely, but possible) of their dealer may, depending on the sufficiency and terms of the local financial industry protection fund, expose you to serious financial loss. In a previous commentary we looked at the existing dealer bankruptcy protection regime. In this part 2 we look at the 4 types of investors who should
be most concerned by the risk of dealer bankruptcy. Read-on to see if you fall into any of those categories. In a future part 3 we will look at what preventive steps can be taken to address this risk.
Introduction
In a previous commentary we looked generally
at the existing dealer bankruptcy protection regime. In this part we look at the
types of investors who may or should be more concerned by the risk of their dealer
bankruptcy.
There are basically four investor-types who
are likely to be more concerned by the potential bankruptcy of their investment
dealer:
- Those for whom a government credit or
guarantee is essential (Government Credit Seekers)
- Investors with large sums invested (Mr. Big
investors)
- Investors who use a major bank broker
subsidiary client and are concerned by the strength of the Canadian financial
system (Doom and Gloom’ers)
- Investors who deal with marginal operators
and other exclusions (Below the radar shops)
We will now look in turn at each.
Government-credit
seekers
Many investors deliberately decide to
allocate a significant portion of their investments to securities that carry a
government direct credit (in Canada, federal, provincial or municipal
governments) or a government guarantee. Such investors would tend to hold bonds
issued directly by, or guaranteed by, a government, and to hold deposits and
GIC’s covered by a government deposit insurance scheme, such as CIDC
(or
its Quebec equivalent
) in Canada.
Unfortunately most investors purchase and
hold their government bonds in an account with their investment dealer in which
the bonds are held in so-called street
form i.e. not registered in the customer’s name (see Wikipedia ). In the event of a dealer bankruptcy the investor’s claim falls from one against
a government body to one against a private industry fund.
We shall look in the third commentary in this
series at how to protect such an investor, but one alternative, which should be
available, is not. In the US, investors can purchase and have their US
government bonds held directly with the US Treasury, and so avoid any
intermediation risk. Regrettably, as a result of lobbying by the Canadian
banking system, the Canadian government has declined to set up a similar system in Canada; for more on
this deplorable situation, see Government of Canada bonds and Minister Flaherty
.
Does the same intermediation risk apply to
the purchase through a financial intermediary of GIC’s issued by issuers who are
covered by a government deposit insurance scheme? We have exchanged
correspondence with both CIDC and CIPF. What we learnt is twofold:
i)
if a dealer goes bankrupt a
typical investor with GIC’s bought and held though that dealer has no claim under the government CDIC
deposit insurance scheme (that scheme
only applies if it is the issuer of the GIC which goes bankrupt)- PDF doc.2149; and
ii)
instead, the investor’s claim
becomes one against the trustee of the bankrupt dealer, and if not entirely
compensated, the investor has a claim against CIPF, a private (i.e. non-government)
financial industry indemnity fund- PDF doc.2150.
Mr. Big
investors
A limit has been placed by CIPF on the
coverage it provides equal to $1 million for losses. Therefore, in a routine bankruptcy (one not
involving an investment dealer so large as to put in doubt the sufficiency of
the CIPF Fund), it is the big investors,
not the small ones, who should be most concerned.
Fortunately the $1 million limit is actually more generous
than it might appear because certain types of accounts are treated separately,
and in addition it is the net losses to which the limit applies i.e.
after the trustee returns available
assets to the dealer’s customers; see CIPF Policy or as a PDF
doc.2152 and an example of the net
loss calculation or
as a PDF
doc.2153
However, if your account is significantly
larger than the average account with your investment dealer, CIPF computation
rules may in effect penalize you when coverage is calculated in the event of a
bankruptcy:
Losses are shared among customers in proportion to their net assets at the
Member, so unless your account is very large in relation to the Member’s other
clients, your share of the loss will likely be below the coverage limit. Source: CIPF web site or as a PDF doc.2151.
<< Start < Prev 1 2 Next > End >> |