As your portfolio grows and at some point you realize your savings reached a significant size, the question will hit you: can I trust my financial institution with all this money?
If you look this up on the internet, there are terms like asset segregation, insurance with a limit of usually 20 thousand EUR, sometimes 100 thousand and a lot of other confusing things. And here is the surprising part: if you had 10 million EUR in ETFs and your broker goes bankrupt, you can get back every single share - but if you had the same 10 million in a bank account, only 100.000 is guaranteed. By the end of this article you'll understand exactly why - and whether it makes sense to split your portfolio across multiple brokers.
Prefer watching? Here's the video version of this article:
What happens when you buy a share on a stock exchange
To set the stage for the whole discussion let's go through what actually happens when you execute a trade in your investment account. So let's say you want to buy 50 shares of VWCE. On one side there is you as the buyer, and on the other side there is someone who sells these 50 shares - it could be the ETF's market maker, but it can be another investor as well - it's the same story. Now - it's not like the seller or the broker of the seller sends 50 shares of VWCE to your broker. In most cases such shares stay where they are and the thing where they are stored is a so-called Central Securities Depository, or in short CSD.
Each trade goes through 3 steps, these are trading, clearing and settlement.
During trading, both parties agree on the price, then during clearing the clearing house calculates who owes what to whom and steps in between the buyer and the seller, guaranteeing the trade even if one side fails, and then in the settlement step the shares are credited to the buyer's account and the seller gets the money.
Now for our discussion, the most important entities are these so-called Central Securities Depositories, or in short CSDs. These are financial market infrastructures that hold and transfer securities. So with a bit of oversimplification, we can say that these are the things where your shares are stored.
There are multiple ones, for example Clearstream where most German securities are held, or Euroclear which operates several national CSDs: for example in France, Belgium, the Netherlands, and the United Kingdom. In the United States the main CSD is the Depository Trust Company, or in short DTC - that is where most of the US-based shares are stored.
This means ultimately your shares are stored in such a CSD - but of course you don't have a contract with a CSD and in most cases you don't have an account there either. Your broker does.
So you can imagine that in each CSD your broker has an account and other brokers have an account as well and if you trade on a regulated exchange then during settlement shares are shuffled across broker accounts and the system makes sure the seller gets the money and the buyer gets the exact same amount of shares they bought.
Where your 50 VWCE end up after settlement: they never travel to your broker - they move between broker accounts inside the CSD.
Central Securities DepositoryCSD
Your broker
account
+50 VWCE
Seller's broker
account
−50 VWCE
Asset segregation
And with this we arrive at the first very important concept when it comes to broker safety - which is asset segregation.
Quick note before we start: in this article I only talk about normal stocks, bonds and ETFs that you buy on a regulated stock exchange - so no options, FX, crypto or anything with leverage.
Usually the broker has a so-called omnibus account in the CSD - this means within the CSD we don't know who exactly owns the given shares, we just know which broker or bank holds those shares and then that broker or bank has its own internal record where they store which customer has what shares in what amount. The term street name comes from this concept - when people say that the shares are stored in street name, it means that in the CSD you don't see the ultimate owner's name, you just see the broker's name.
An omnibus account: the CSD only sees one account in the broker's name (street name). Who owns what is in the broker's own records - and those have to add up to exactly what sits at the CSD.
Central Securities DepositoryCSD
Omnibus account
Account holder
Your brokerSTREET NAME
Holdings
1.250 × VWCE
Owners unknown to the CSD
Your broker · internal records
Total ✓ = omnibus account at the CSD1.250
And here comes the asset segregation part: even though shares are in street name, it's legally enforced that these shares belong to the bank's or broker's customers and not to the broker itself. So if the bank or broker executes their own trade, then it's prohibited to use any of the accounts where customer assets are stored - those need to be segregated, unless the customer explicitly consents, e.g. to securities lending.
The important rules here are MiFID II (Directive 2014/65/EU, Article 16, detailed in Delegated Directive (EU) 2017/593) and national insolvency law. The first legally requires banks and brokers to segregate their own assets from customers' assets, the second one makes sure that in case the bank or broker fails, then these assets are handed out to the customers, because they are owned by the customer and not by the bank. The insolvency laws in case of a financial institution are not defined at the EU level, but the core principle is the same in every EU country: customer assets need to be handed over to customers and they are never part of the insolvency estate. And thanks to the asset segregation regulation that I mentioned before, it is very clear which assets belong to customers.
Now before we move on, two quick side notes.
- First of all, it's not like every bank and broker has an account in a CSD - this can have multiple reasons, one is that this is fairly expensive, and second is that having an account in every single CSD is operationally complex and only very big institutions are able to do so. So usually brokers partner with other financial institutions and they use their partner - or sometimes a partner of a partner to store assets in a specific CSD.
- And second - what I described before with the omnibus account is the default way of how this is implemented, but that is not the only option. Every EU CSD offers - and this is a legal requirement - the option to hold assets in a segregated account for a single client. This means that you as the owner of a given security have an account - or at least a sub account - in the CSD. The costs here depend on the CSD, the broker itself and on some other things and they can be radically different - in some cases this can be just a few euros in additional cost, in some cases tens of thousands. I won't bombard you with links in multiple languages, but if you are interested in this, just let me know and we can go into this.
And this is the first answer to our question in this article - as we just discussed - in case of a broker bankruptcy customer assets need to be handed over to the legal owners of the assets and those assets are always segregated from the broker's assets.
So your broker goes bankrupt, you open an account with another financial institution, then you tell the details of this account to the insolvency administrator and they just move the accounts within the CSD to your new broker. So this means that you don't lose your assets. Your assets in a brokerage account are yours and this whole legal framework that I just described is in place, so your assets can be recovered after a bankruptcy, even if it may take some time.
Now this assumes asset segregation works - which again, that is a legal requirement for any broker to be able to operate. But unfortunately that's not always the reality.
When things go wrong - and shares are not where they need to be
If things go wrong, asset segregation may not work. There can be multiple reasons here, but the most common one is probably that the financial institution, so basically the broker knowingly or unknowingly messes something up. I'd like to make it very clear that at this point we are already in the territory where the broker broke the rules - sometimes by mistake, sometimes through fraud - and the likelihood that someone ends up in jail is at this point non-zero.
So this is the case where the assets on the accounts within the CSDs are not covering every single broker customer to 100%. So this is when assets are missing.
Before we go into the insurance part let's see what happens in this case with the assets that are still in the CSD.
In previous broker insolvencies combined with fraud the usual outcome is that some of the assets are missing - but not all of them. That'd be almost impossible. What typically happens is that a broker has different securities - so a whole bunch of bonds, shares of companies, ETFs and things like that - of each type of security they hold multiple units.
So let's say the broker somehow managed to use some of the shares for its own purposes, and they are gone. Let's take an example - in this example I'll simplify things and use lower numbers on purpose to make things easier, but the real world is the same, just with more complicated numbers.
So let's say we have a broker with 2 customers - customer 1 has 20 shares of VWCE and 80 shares of Microsoft, and customer 2 has 40 shares of VWCE and 20 shares of Microsoft.
This means the broker itself held 60 shares of VWCE in one of the CSDs and 100 shares of Microsoft. Now let's assume they steal a quarter of the VWCE shares.
In this case the insolvency administrator will inform the customers that they found 45 shares of VWCE and 100 shares of Microsoft. In most EU countries, the shares are given back to customers pro rata based on the records the broker has. This means that from the 100 shares of Microsoft 80% belongs to customer 1 and 20% belongs to customer 2 and given the fact that we had all the 100 shares, everyone will get all their Microsoft shares back. For VWCE from the original 60 shares 20 belong to customer 1, which is one third, and 40 belong to customer 2, which is two thirds. But we only have three quarters of it, so the 45 VWCE shares are split across the two customers based on the previous numbers. One third - meaning 15 shares go to customer 1 and two thirds meaning 30 shares go to customer 2.
And the missing 5 and 10 shares are the ones where the Investor Compensation Schemes can compensate these losses.
So here is the more precise answer to our original question: when your broker goes bankrupt, assets that are recoverable are given back to you, but in case something is missing, what's left is shared among all customers in proportion to what they owned. And the missing part may be compensated by the Investor Compensation Schemes.
The Investor Compensation Scheme
Now let's talk about the investor compensation scheme that people usually bring up in combination with broker failures. So as already hinted before, this will only apply if assets are missing - if a broker is wound down in an ordinary manner, then there is nothing to compensate, you just get back your assets and that's it. The reason I bring this up is that people sometimes think that the Investor Compensation Scheme is your main insurance, but I'd say it's more like a backup - your main insurance is the asset segregation and the fact that your assets are - well, your assets - and not the broker's assets.
The investor compensation scheme is generally defined at the EU level, in the Investor Compensation Schemes Directive (97/9/EC), and the minimum of it is 20.000 EUR - basically every single EU member that implements this directive has their own national implementation of this and some of them have a higher limit.
Here are a few examples:
Which national limit is applied to your account is usually defined by the broker - and this is always a broker-customer pair. So regardless of where you are located if you have an account with a German broker, then the limit is typically 20.000 EUR. If you open a second account with the same broker, then the limit is still 20.000 EUR. But if you open another account with another broker in Germany - and by that I mean a separate legal entity, not just another brand of the same bank - then you'll have the limit applied twice - so once for the first broker and once for the second broker - meaning 40.000 EUR in total.
And this limit applies to the missing assets. So going back to our previous example, we had 5 VWCE missing from customer 1 and 10 missing from customer 2. The current value of this is 850 EUR in case of the first customer, and 1.700 EUR in case of the second one. And that would be below the limit of the Investor Compensation Schemes in every EU country, so they'll just receive that amount in cash - or 90% of it in countries like Germany or the Czech Republic.
Let's say in case of another customer there are 200 pieces of VWCE missing and this customer is let's say in Germany with a 20.000 EUR limit. In this case the current value of the missing package is 34.000 EUR - this means the first 20.000 EUR will be compensated and the remaining 14.000 EUR is not covered.
Now, you may say that these limits are extremely low - and I personally would agree with that. In my opinion the 20.000 EUR that most countries define is a bad joke and even the 100.000 is debatable. For comparison, the United States has a similar regulation to what we have in Europe, so they also have asset segregation with an insurance on top of it in case investors' assets are not recoverable - that is the SIPC and the limit there is half a million dollars.
Of course, like I said, the more important part is the asset segregation and that's what ultimately protects the customers.
The other reason - and most people don't know this - is how the math actually works when assets are missing. Let's say you have 25.000 EUR in VWCE at an Austrian broker, so the limit is 20.000 EUR. And remember: if assets are missing, what's left is shared among all customers pro rata.
So if 20% of all the VWCE shares at the broker are missing, you get back 20.000 EUR worth of shares, 5.000 EUR is missing, and the Investor Compensation Scheme pays you the full 5.000 EUR. You lose nothing.
If half of it is missing, you get back 12.500 EUR in shares, and 12.500 EUR from the compensation scheme. You still lose nothing.
Even if 80% is missing, you get back 5.000 EUR in shares and 20.000 EUR from the compensation scheme. Still nothing lost.
So for you to lose even a single euro, more than 80% of all the VWCE shares that the broker holds for all of its customers would have to disappear. And for a popular ETF like VWCE, where a broker holds a huge amount of shares for thousands of customers, that's not a small mistake - that would be a gigantic fraud.
Shares recoveredPaid by the compensation schemeLoss
20% missing20.000 EUR + 5.000 EUR
50% missing12.500 EUR + 12.500 EUR
80% missing5.000 EUR + 20.000 EUR
90% missing2.500 EUR + 20.000 EUR + 2.500 EUR lost
25.000 EUR of VWCE at a broker with a 20.000 EUR compensation limit. The loss only appears once more than 80% of the broker's VWCE shares are missing.
So do not just blindly open an account just because you are above your Investor Compensation limit - it would make very little sense.
Bank deposits vs. securities accounts
Now let's talk a little bit about bank deposits, because sometimes people are confused about this. Bank deposits work completely differently. Everything I explained before applies to securities accounts - so bonds, stocks, ETFs, things like that. They are yours.
Bank deposits on a bank account are different. That is basically a loan to a bank - and that is true for a normal bank account as well! You have a claim against the bank, and the money that you deposited to the bank is on the bank's balance sheet. This means, there is no asset segregation in case of a bank account. Everything is the bank's money and the bank owes you the money. You are legally a lender.
Now this may sound strange, but that is exactly what the legal framework says - this is defined in national civil law, it's a bit different in every country, but the point is the same: you loan money to a bank and you are a lender.
And banks can go bankrupt as well. And for this scenario there is also an EU level rule. We have another compensation scheme that applies to bank accounts, defined in the Deposit Guarantee Schemes Directive. And this compensation scheme has a 100.000 EUR limit.
But the big difference here is that there is no asset segregation here. If you had let's say 200.000 on a bank account and the bank goes bankrupt and we assume the bank doesn't have any additional insurance, just the legally required minimum, then only half of your money is guaranteed - for the other half you are just a creditor in the insolvency, and you may get back some of it or nothing.
So the huge difference is that in case of a brokerage account the assets are yours and in case the broker doesn't do anything illegal, you don't lose anything - no matter what amount of assets you had - if you had 1, 2 or 10 million in different ETFs, you'll get back your ETFs. If you had 1, 2, or 10 million EUR on a bank account and your bank goes under, you're only guaranteed 100.000 even if the bank didn't do anything illegal.
10 million EUR, and the institution goes under. 1 square = 100.000 EUR.
Brokerage account · ETFs
You get back your ETFs
All of them - if the broker didn't break the rules
Bank account · cash
100.000 EUR guaranteed
1% - even if the bank did nothing illegal
Should you diversify across multiple brokers?
The usual question that people bring up is whether they should diversify their assets across multiple brokers in order to achieve a higher coverage, or just to be on the safe side in general. My personal take on this is that the most important step is to choose a financial institution that is big and old enough to avoid shady businesses. I think that is the more important part. Yes, it may be a bit more expensive and their app may not be super fancy, but in my opinion investing through the shiny new mobile app of a startup that was founded last year is a recipe for disaster - regardless of the regulation and compensation limits.
Just to take an example, most of the bigger institutions are publicly traded companies that are reporting every quarter and an army of analysts look at them - if something goes wrong, you'll see that on their stock price. Additionally some of them have a public rating from a credit rating agency. In comparison, most neobrokers are private companies - you only see their annual reports, they don't have ratings from an external rating agency and not to mention that their customer support is often non-existent.
I personally think that the regulatory framework on asset segregation is decent and that is your first line of defense. And of course that is the same for all financial institutions, no matter what. But even if you don't lose any of your assets in case of a bankruptcy - trust me, you would not enjoy the process of collecting your assets in case of such a bankruptcy.
So I think the first step is choosing a broker that doesn't go bankrupt - and this may sound silly, but you can easily collect data on how big the given institution is, how long they have been operating and things like that.
But to go back to the broker diversification question: In my personal opinion if you are just starting out, and your portfolio is let's say below 100.000 EUR, I don't think you'd gain much security by having multiple accounts at multiple brokers. Your advantage is your earning potential and income and not your portfolio. On the other hand, if you already saved money for a very long time and your portfolio would cover your living expenses for multiple years or a decade or even longer, then I personally would think about opening accounts with multiple brokers. Not necessarily because of a potential bankruptcy, but just in case there is an outage, or if the broker suddenly starts doing strange things, you can easily switch if needed.
Recap
So let's quickly recap.
- First, your shares are yours. Thanks to asset segregation, if your broker goes bankrupt, you get your assets back - no matter if it's 10 thousand or 10 million EUR, as long as nothing is missing.
- Second, the Investor Compensation Scheme is only a backup for the case when assets are missing - and with 20.000 EUR in most countries, it's not much of a backup.
- And third, bank deposits are a completely different story - there you are legally a lender, and only 100.000 EUR is guaranteed.
Disclaimer
This article reflects the personal opinion of the author, and does not represent the views of any business partner, or affiliated entity.
Nothing in this article constitutes financial, investment, legal, or tax advice. It does not take into account your individual financial situation, investment objectives, risk tolerance, or tax circumstances, and it is not a personal recommendation to buy, sell, or hold any specific financial instrument, or to open or close an account with any specific financial institution. The information is provided for general informational and educational purposes only. Before making any investment decision, you should consult a licensed financial/investment advisor who can assess your personal situation.
Compensation limits, regulations, insolvency procedures, prices, and other data mentioned in this article were accurate to the best of the author's knowledge at the time of writing but may have changed since publication and are not independently guaranteed. The description of EU and national rules on asset segregation, insolvency, investor compensation, and deposit guarantees is simplified, the examples are illustrative only, and the actual outcome of a specific insolvency depends on the applicable national law, the institution involved, and the terms of your account.
The author accepts no liability for any loss arising from the use of, or reliance on, the information in this article.
