Investor compensation schemes: who pays when the firm cannot

An investor compensation scheme is a pooled fund that pays you a capped amount if the firm holding your money collapses and cannot give it back. It is insurance against the firm failing, not against your positions losing.

That distinction is the whole subject. Almost every misunderstanding about these schemes comes from blurring two very different events: the firm breaking, and the market moving against you. A scheme addresses the first and has nothing at all to say about the second.

Why a pooled fund exists in the first place

When you deposit money with a venue, you stop holding cash and start holding a claim. The firm owes you a balance. Whether that claim is worth anything depends on whether the firm can honour it, which depends on how the firm is run, how it keeps records, and whether anyone has helped themselves to the pot.

Normal insolvency law handles this badly for retail clients. An insolvency practitioner has to identify whose money is whose, from the failed firm’s own records, and then distribute what remains. If the records are good and the money was properly separated, clients get most of it back, slowly. If the records are a mess, or the money was mixed with the firm’s own, the shortfall is real and it is shared out proportionally. Either way the process takes a long time, and the client has no way to influence it.

A compensation scheme is a shortcut around that. Licensed firms pay levies into a common fund as a condition of holding a licence. When one of them fails, the fund pays eligible clients directly, up to a limit, and then stands in the client’s place as a creditor in the insolvency. The scheme recovers what it can, later, on its own time.

Two things follow from how it is funded. First, cover is capped, because the surviving firms funding the pool cannot be exposed to unlimited liability from a competitor’s collapse. Second, cover is per person per firm, not per account, because the levy model prices failure by firm.

What the scheme actually responds to

A claim turns on one question: is money or property that the firm was supposed to be holding for you now unavailable because the firm failed? If the answer is yes, that is the event the scheme was built for. Shortfalls in segregated client money, assets held in custody that are not there, balances owed and unpaid at the point of collapse.

What it does not respond to is anything that is just the market working. Suppose, purely as made-up numbers, you hold a position worth $4,000 and the market moves against you until it is worth $1,500. You have lost $2,500. Nothing has gone wrong with the firm’s custody of your money: your account correctly shows $1,500 and the firm can pay you $1,500 on request. There is no shortfall, so there is no claim. The scheme would not pay a cent of that $2,500, and it was never intended to.

Now change one fact. Keep the position at $4,000, with the market flat, and have the firm fail with a shortfall in client money. Say, again as an invented figure, the scheme’s cap is $20,000 per person per firm. Your $4,000 claim sits well under that cap, so in principle the scheme can make you whole. Raise the balance to $60,000 against the same invented $20,000 cap and the arithmetic changes shape: $20,000 comes from the scheme, and the remaining $40,000 becomes an ordinary claim in the insolvency, worth whatever the estate eventually pays out on each dollar. Those made-up numbers are there to show the method, not to describe any real limit.

This is why caps matter more as your balance grows. Below the cap, the scheme is close to a guarantee. Above it, your protection is diluted in proportion to how far above you sit.

Cover follows the entity, not the logo

Here is the part people get wrong, and it is specific.

A trading brand is not a company. It is a name that one or more companies trade under. A single app, with one logo and one sign-up flow, can route clients to different legal entities depending on where they live, which product they asked for, or simply which entity had capacity when they registered. Those entities can hold different licences, or none. Only some of them are members of a compensation scheme.

So the mistake is reading a scheme logo or a licence number in a website footer and concluding that your account is covered. The footer often lists every entity in the group. Your cover depends on exactly one of them: the entity named as the counterparty in the client agreement you signed. If that agreement names an entity in a jurisdiction with no scheme, the scheme mentioned elsewhere on the site is not yours. Nothing about the interface will look different. The onboarding, the platform, the support chat and the branding are identical either way.

The practical version of this check is short:

1. Open the client agreement or terms you accepted, not the marketing pages.
2. Find the named counterparty: a company name, a company number, a registered address.
3. Check whether that specific named entity, not its parent and not its sibling, claims scheme membership.
4. Check what product you are actually trading, because membership can cover some instruments at that entity and not others.

A second, related error is assuming the scheme pays automatically and quickly. It generally does not pay until the firm has been formally determined to be in default, which is a decision the scheme makes on its own timetable after the failure. The protection is real, but it is not a same-week refund.

How to reason about it next time

Treat a compensation scheme as one layer in a stack, not as a verdict on whether a firm is safe. Segregation is supposed to keep your money out of reach of the firm’s creditors. Capital requirements are supposed to make failure less likely. A scheme is what catches you when the first two did not hold. Checking only the last layer tells you what happens after things break, not how likely they are to break.

And when the balance in an account grows past the point where a cap would make you whole, the cap stops being the main safeguard. From there, what protects you is spreading the balance across entities, or not leaving it sitting with a venue at all. See also our notes on segregated client money, what a regulated broker actually means, and the pre-trade checklist.

Education only, not financial advice. Trading carries a risk of loss.