What Investor Protection Do You Have


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Following recent press articles, this is a good time to remind savers and investors to establish what level of investor protection they have.

Following recent press articles, this is a good time to remind savers and investors to establish what level of investor protection they have.

Stress tests on European insurers

The European Insurance and Occupational Pensions Authority (EIOPA) has published the results of its second insurance stress tests, designed to assess the sector?s financial resilience. Nearly 10% of insurers failed.

The tests uncovered a solvency deficit of around ?4.35 billion when the companies were subjected to an adverse scenario where share prices fell 15%, interest rates dropped and the property market crashed.

They also included insurance specific tests related to natural catastrophes and things that affect liabilities rather than assets.

13 of the participating groups would fall short of the Solvency II Minimum Capital Requirements – the regulatory threshold due to be implemented in 2013 – and would need to find ?4.4 billion between them in new capital if there was another financial crisis.

Overall, though, the new European Regulator (EIOPA) stressed that the European insurance market is ?well prepared for potential future shocks? and that the second round of tests are not necessarily indicative of any current solvency problems.

Between the time of writing and publication, the European Banking Authority published the results of its stress tests which tested the resilience of 90 banks against a prolonged economic downturn. Eight banks failed (five Spanish, two Greek and one Austrian) and need to raise ?2.5 billion in capital between them. Another 16 lenders need to strengthen their balance sheets. Spanish and Italian lending banks were the strongest performers.

The tests have been criticised for not being tough enough but the EBA argues that they were ?rigorous?.

Bad debt warning for UK banks

The Bank of England?s latest Financial Stability Report found that UK banks have been much more lenient with loans in arrears than they were in previous economic downturns. This could cause problems if the economy were to weaken further.

Governor Mervyn King is concerned that the number of potentially bad mortgage loans may not be fully taken into account, which would make reports on the health of the UK banking industry ?misleading?.

It is estimated that Lloyds Banking Group has twice the number of risky mortgages than other lenders. Around 60% of its secured lending has a high or very high loan-to-value ratio, where the loan is worth between 70% and 90% of the property?s value. Borrowers with small deposits are twice as likely to fall into arrears than those with higher deposits.

Lloyds is therefore particularly vulnerable to any further economic dips, particularly if house prices fall. The Financial Times described the situation as ?potentially a ticking time bomb for Britain?s largest high-street lender?.

A Financial Times report found that 13% of the loans on Lloyds? mortgage books are worth more than the value of the property they are secured against.

Royal Bank of Scotland and Santander also have a significant number of high loan-to-value mortgages.

The International Monetary Fund had warned in May that, by helping customers who are struggling to repay their loans, British banks could have ?masked? the scale of the potential dangers. While they may appear to be adequately funded to withstand a shock, they may not actually be able to in practice.

Banks were thought to be extending loans, reducing interest rates and shifting people onto interest only deals ? a practice known as ?lender forebearance?.

Small UK bank collapses and savers lose money

While there was no reason for it to cause general alarm, the collapse of a small south coast bank is significant nonetheless as it was the first time since the 1990s that savers lost money.

Southsea Mortgage and Investment Company, a 50 year old one-branch bank, ceased trading and was placed in the Bank Insolvency Procedure in June. Savers are protected under the Financial Services Compensation Scheme, but the maximum guaranteed is ?85,000 per customer.

During the banking crisis the government had stepped in to guarantee all deposits however large, but not did not do so this time so anything above ?85,000 could be lost.

While few savers were affected at this small bank, what would happen if a larger bank collapses? It?s dangerous to expect the government to repay savings above the compensation limit should a bank collapse.

The bank had been offering an interest rate of 4.5% before the collapse ? considerably higher than more conventional banks. If a non-nationalised bank offers an interest rate which is much higher than the central bank base rate there is always an element of institutional risk .

Irish banks

Despite complex manoeuvres by the Irish authorities, lender Allied Irish Banks has defaulted on debt. Banks that had sold insurance on the bank?s debt will have to pay out to investors.

The lender had stopped interest payments on some of its bonds and postponed their repayment dates, causing the International Swaps and Derivatives Association (ISDA) to declare that a ?failure to pay credit event? had occurred, which meant the bank has effectively defaulted – something the Irish government had been desperately trying to avoid.

The decision was in line with market expectations and only covered a relatively small amount of bonds, so did not cause much concern. However it sets a precedent for upcoming decisions on Bank of Ireland – the only major Irish bank not to be fully nationalised – debt.

The bank is the second Irish institution to default after Anglo Irish Banks triggered restructuring and failure-to-pay credit events last year.

Investor protection

The level of investor protection you have varies according to the financial arrangements and the country they are managed and regulated in. Whether you have bank savings, investments or insurance arrangements, you should establish exactly how you are protected and to what extent in the event of institutional failure.

Many savers with larger cash deposits have spread them out over more than one bank so that every Euro or Pound should be protected in the worst case scenario. Others have opted to move capital into arrangements which provide a higher level of investor protection than banks can offer. For example Luxembourg offers one of the best investor protection regimes in Europe – its state controlled protection law is designed to provide maximum security to investors without limit. If you have an investment bond issued by a Luxembourg regulated insurance company, your investment assets are completely protected should the insurance company fail.

For advice on asset protection consult a regulated advisory firm such as Blevins Franks Financial Management Ltd.

7th July 2011, updated 18th July 2011

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.