Last Updated on December 19, 2020 by Oddmund Groette
In Street Name
Your capital is at risk when you are investing in equity markets, but I assume very few consider the broker as a potential risk. But the fact is that your capital might be at risk if the broker goes bankrupt. Not only your cash deposit but also your shareholdings. How is this possible?
I believe most investors don’t know that their assets in most brokers are held in street name. In layman’s terms, this means the brokerage is the official owner of the stocks, while you are the beneficial owner of the rights. The shares are simply owned by the brokerage on behalf of you. Sometimes this is called nominee accounts. When shares are officially owned by the broker, you as a beneficial owner don’t appear in the share register. Dividends and other rights are hence sent to the broker who disperses to the owners on their books.
This article looks at Interactive Brokers and Degiro, but the arguments are relevant to almost any broker.
Why “street name”?
The argument is to facilitate a quick and cheap change of ownership. However, to me the argument sounds like utter rubbish.
Norway has for over two decades run a separate share registry, completely independent from the brokers. This is bulletproof and the ownership is completely separated from the broker. Fees and costs are just as low in Norway as anywhere else, so to me the argument of efficiency sounds pretty weak. The share registry is of course completely electronic.
Implications of “street name”
When you are not the official owner, you are obviously not the owner. This makes you at risk for improper behavior by the broker and/or liable to losses if the broker experiences financial difficulties. If the broker goes bankrupt you simply have a claim against the broker together with other claimants. To remedy this almost all US broker-dealers are members of the Securities Investor Protection Corporation (SIPC). This insurance covers your deposit up to 500 000 USD, but only up to 250 000 USD for the cash portion. In the UK you are insured up to 50 000 GBP, and in the EU up to 20 000 EUR. Any deposits above these limits mean your capital is at risk, plain and simple.
I invest long-term via Interactive Brokers, a Scandinavian bank and one Scandinavian retail broker, in total three different brokers. I feel pretty safe in two of them as they are based in Scandinavia. However, I invest in stocks outside Scandinavia via Interactive Brokers (IB). My deposit has been held in its UK affiliate (Interactive Brokers (U.K.) Limited (“IBUK”)), and as such received insurance from the US SIPC:
As IBUK clients are carried by our US broker, IBL, the securities segment of their account may be eligible for insurance by the Securities Investor Protection Corporation (“SIPC”) at an amount of up to USD 500,000 (subject to a cash sublimit of USD 250,000).
Unfortunately, this ends with Brexit. My business with IB will be with a Hungarian regulated entity and the losses covered is up to 100 000 EUR:
- 100% up to the limit of the EUR equivalent of one million forints (EUR 2,800 on 12th December 2020),
- above one million forints: 1 million forints and 90% of the part above one million forints to a maximum of EUR 100,000.
In plain English, my insurance has gone from 500 000 USD to a pretty mediocre 100 000 EUR. IB has a long history, but in no way do I trust their risk management. This is a typical business prone to tail-risk and system risk in the financial system, no matter how financially sound IB might be.
Some years back I asked IB if they considered setting up a separate entity as a custodian (for a higher fee/commission), but the answer was negative.
Is Degiro safe? The Dutch broker Ddegiro has an option where you can pay slightly more in fees/commissions for transferring your shares to a separate entity to avoid any risk of ruin:
At DEGIRO you can rest assured that your investments are held securely. DEGIRO uses a separate legal entity (SPV) to hold your assets. This means they are held separate from the assets of DEGIRO. The sole task of this entity is to administer and safeguard your investments. By law, it cannot perform any commercial activities. In the event that something would happen to DEGIRO, your investments will not be treated as recoverable assets to DEGIRO’s creditors and will remain in the safekeeping of the separate entity. This entity will hold your assets with third parties. Where possible or legally required, DEGIRO will require these third parties to provide for asset segregation so as to protect the investments of the clients of DEGIRO against their bankruptcy. Rules with regard to asset segregation are different in every country (both within the EU and outside the EU). If there is no asset segregation in relation to a third party in the custody chain, then the financial instruments held with that third party might be lost in case of the bankruptcy of that party.
If you have significant capital in any broker I recommend looking at the legal terms. The financial system is interconnected globally and problems in any corner of the world can spread like wildfire within the financial system. Be prudent and diversify your holdings.