Client money

Segregation

When a client deposits money, the broker either puts it in a separate bank account held on trust for clients or mixes it with its own funds. The first is segregation, and the regulators in the United Kingdom, the European Union, Australia, Japan and Singapore require it: client money must be held in designated accounts at banks, reconciled daily, and never used for the broker's own purposes. If the broker fails, an administrator can identify the client money and return it, which is what happened when Alpari UK collapsed in 2015 and its clients were largely repaid.

Where segregation is not required, or is required in name but not audited, client money is simply the broker's money with a promise attached. If the broker fails, the client is an unsecured creditor, which is what the customers of Refco's forex arm discovered in 2005 and what clients of small offshore brokers discover every year.

What segregation does not do

Segregation protects money on deposit from the broker's insolvency. It does not protect a trading account from trading losses, and it does not by itself guarantee the money is safe from fraud, because a broker that is prepared to break the rules can break this one too, as MF Global did in 2011. It also does not cover money that has left the client account: a deposit in transit through a payment provider, or a withdrawal the broker has approved but not yet paid, sits outside the trust.

Compensation schemes

A few jurisdictions go further and stand a fund behind the broker. The United Kingdom's Financial Services Compensation Scheme pays eligible clients up to 85,000 pounds if a regulated firm fails and cannot return their money. Cyprus's Investor Compensation Fund covers up to 20,000 euros. Similar schemes exist in some other European countries. Australia, the United States for forex dealers, and every offshore centre have none: segregation is the only protection, where it applies at all.

The bank behind the account

Segregated money sits in a bank, and the bank can fail too. The rules in the stricter jurisdictions require brokers to use banks that meet a standard and to spread money across more than one, and some brokers publish which banks they use. A broker holding client money at a small bank in its own offshore jurisdiction offers less than one holding it at a large bank in a country with deposit insurance, even if both call it segregation.

How much to keep with a broker

The practical rule follows from the above. With an entity covered by a compensation scheme, keep no more than the scheme's limit. With a regulated entity that segregates but has no scheme, keep what you need to trade and withdraw the rest. With an offshore entity, keep the minimum that supports your positions, and treat anything above it as money at the broker's risk. The broker failures paper in the research section goes through the cases the rule is drawn from, and the site records the client money rules and any compensation scheme for each entity on the database.