Insurance or Guarantee of Invested Funds

Question

I have done some basic research but I cannot seem to find a direct answer about whether my funds are insured or if there is some sort of guarantee for individuals investing through Pearler:

I understand that "The Australian Government guarantees up to $250 000 per account holder per authorised deposit-taking institution (ADI)" but this does not apply to Pearler (or other stock investment accounts as I understand it), correct? I also get that Pearler is CHESS sponsored but this does not guarantee me ownership/access over my investment, say, if the company became insolvent?

Any help appreciated, thank you in advance!

Answer

Hi Mary!

Owen Rask here. You’ve touched on a really good — but technical — point, the way custody and stock ownership works in Australia.

To be clear: I can only provide general financial information, especially on this topic. So, please, always read the T&amp;C’s, product disclosure statement (PDS) and financial services licensing information (and verify a broker’s AFSL via ASIC’s website because you click a link to their website). And before acting on this information speak with an adviser or lawyer.

Over at Rask HQ, we’ve just recorded another episode of our Australian Finance Podcast series talking about brokers (not just Pearler, but all of the most common brokers in our community). It’ll be aired in the next 2 weeks.

The key distinction you touched on is the difference between HIN/CHESS-sponsored platforms and custody models.

Custody models are most common overseas — for example, for US shares, as far as I know every platform uses a custodial model. This means that the broker for a US investor (or an Aussie investor looking at US stocks) enters into an agreement (even if they may not know it) with a complex web of providers (the broker, trustees, service providers, the custodian themselves, etc.).

The key difference between, say, a crypto provider (e.g. FTX) and a legitimate financial services organisation is the financial services business is properly regulated. For example, in the US, you have organisations like the SEC, Securities Investor Protection Corporation (SIPC), banking regulators, state &amp; federal laws, the police, etc. Protections come with a ‘cost’ — but I’m happy to pay it!

Advocates of blockchain try to get around this, but at the end of the day the organisations ‘centralise’ regulation for the sole reason of protecting investors. Sure, brokers can still go bust. And people can still do the wrong thing. It’s just more difficult for regulated firms.

Managed funds («mutual funds» in the USA) operate on a custodial model. But again, they’re regulated (and have things like PDS’ so you can understand the finer points). So again, custodial models are normal — but they require good oversight.

Here in Australia, basically, the HIN (Holder Identification Number) is another protection on top. In the case of Pearler (and quite a few other popular brokers like CommSec, Selfwealth, Stake, etc.) the HIN is provided because it gives people comfort that if the broker goes bust there is a ‘line of sight’ between us (the investors) and the actual shares or ETFs we own.

This is provided by the ASX system, regulated by ASIC — both of which are governed by the Corporations Act — which is the Australian Government’s all encompassing law book. For example, if I buy Telstra shares with my HIN, my unique number will appear alongside the exact shares I own. While I might see this number inside my brokerage account, it’ll also appear on the share registry (Link Market Services), and in ASX records. Pardon the pun, but if one ‘link’ in that chain broke, you still see that I own X-number of Telstra shares.

The custodial model (i.e. without a HIN) is a little different. Instead, there is ‘one big HIN’ at the broker level (e.g. ‘Broker ABC holds 10 million Telstra shares’), and then within that broker (or their custodian) you will find a database of the individual investors owning, say, 50 Telstra shares. So in this instance, the broker lowers the cost of trading for its users because it doesn’t have to ‘pay for the protection of individual HINs’.

Again, I want to be clear: custodial models are the most common globally. HIN is unique to Australia. Brokers around the world are typically also part of insurance schemes (SIPC in the US, SEGC in Aus).

Resources:
https://education.rask.com.au/2021/07/12/brok...
https://www.segc.com.au/
https://www.sipc.org/

I’m especially keen to understand the nitty-gritty, so I’m glad I’m not the only one 🙂

Owen

Answer

Hey Mary.The government guarantee refers essentially to bank accounts, correct.There are two short blog posts Pearler has created around this topic which might help:«Why your shares are safe with Pearler» - https://pearler.com/explore/learn/blog/why-yo...«Why your cash is safe with Pearler» – https://pearler.com/learn/blog/why-your-cash-...Basically, your shares/investments will be moved over/transferred to another broker if something happens to Pearler. You are always the owner of the assets. CHESS means your name is recorded with the Australian Securities Exchange (ASX) as the legal owner of shares. Pearler or other CHESS sponsored brokers are really just the middleman helping you buy these assets.My understanding is Micro is run a bit differently, given the functionality it offers. In this case (unless someone can explain better!), the Micro funds are operated like a managed fund which is held in trust with you as the beneficial owner. Again, if something were to happen with Pearler here, my understanding is that the Micro funds can be passed on to another financial institution to manage on your behalf.Hope that helps :)Dave

Answer

When you buy stocks, through pearler or commsec, you become a part owner of the company. You own a share in it. That ownership is registered with CHESS. So you do have guaranteed ownership.
If the company goes bust, your access is more limited. You are probably out of luck as you will be a creditor in the line of people queued up to get some fraction of what is left in the winding up of the company. People who have lent money to the company are nearer the front of the queue than you. They are the bond holders. This is why stocks are riskier than shares. On the other hand stock prices and perhaps dividends have no upper limit, whereas bond holders are capped at the interest rate when they purchased it. Hence a difference to risk/reward on investments. ADIs are less risky again, and have lower returns again.

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