What Are Segregated Accounts? Pros & Cons & How They Work (2024)

Key Takeaways

Opening an account is no longer about waiting in queues and paperwork at the bank. In today’s digital age, the financial world has introduced us to alternative banking solutions, like virtual bank accounts and neobanks.

In fact, almost half (47%) of new accounts opened in recent years are with digital banks and fintech companies that offer a modern alternative to traditional banks.

But can you really trust non-bank alternatives? How can you make sure your money is safe? How do they safeguard your deposits? This is where segregated accounts come in.

In this article, we will explain a segregated account, how it works, and its benefits for businesses and clients. This will give you peace of mind when using financial services provided by fintech companies. Let's start with the basics: What are segregated accounts?

Segregated accounts are separate bank accounts where a company holds its clients’ money individually, preventing it from commingling with the company's own funds. They are accounts held by a financial institution on behalf of a business.

Segregated accounts are typically used in industries that involve an authorised third party handling customer funds, such as fintech payment service providers, brokerage firms, investment management, and insurance companies.

Their main purpose is to safeguard the client's assets against any wrong use by the company holding them. These separate accounts also ensure that the customer assets are protected in case the company fails or goes bankrupt.

Segregated accounts are also a common regulatory practice in most jurisdictions.

For example, the Securities and Futures Commission of Hong Kong (SFC) requires companies to keep client funds in segregated accounts with authorised financial institutions. Similarly, the UK's Financial Conduct Authority (FCA) has strict rules in place, known as the Client Assets Sourcebook (CASS). The US Securities and Exchange Commission (SEC) also mandates the segregation of customer funds for broker-dealers.

Insider Tip: If you are planning to use the services of providers that are required by law to keep your assets and money in a separate account, be sure to ask about their policies on segregated bank accounts to ensure that your funds are safe.

Here’s a breakdown of how it works:

1. Client makes the deposit: A client deposits money into their account with a company, such as a payment service provider or an investment firm.
2. The company transfers the deposit to a segregated account: The company then transfer the funds to a segregated account allocated to the client instead of keeping it in its general operating account.
3. The deposit reaches the segregated account: This segregated account is completely separate from the company’s own account. It has its own unique account details and can be clearly identified.

It’s important to note that transactions involving segregated accounts are fully traceable, meaning that the client can track where their money is and see that their funds are handled properly.

Generally, fintech companies that handle client’s money, such as payment service providers, account providers, remittance companies, and investment platforms, will keep each client’s funds in segregated accounts. They are responsible for opening a segregated account for each of their clients.

It is also common for asset management and brokerage firms to hold client funds in segregated accounts for trading and investment purposes.

These segregated accounts are typically provided by licensed financial institutions. Some banks also offer segregated accounts as a specialised service for businesses or high-net-worth individuals.

Since segregated accounts are used in many industries, the advantages can vary significantly depending on who and what these accounts are used for.

Essentially, the main advantage is avoiding commingling assets or mixing funds. Segregated accounts are legally separated from the company's assets, meaning the company cannot use the client’s deposits for their own business operations.

This clear separation ensures that both the client and the company maintain good financial health. The clients can retain cash flow liquidity and access their funds at any time while the company keeps its finances organised and transparent.

Let’s take a closer look at the advantages of segregated accounts for the company and the client.

Segregated accounts offer significant advantages beyond legal compliance for companies across various industries, including:

• Credibility: Segregated accounts demonstrate transparent financial management and how client funds are handled, building trust between the company and the client.
• Operational Efficiency: By keeping client funds separate, companies can simplify their accounting and financial reporting processes. This also reduces errors and makes audits more efficient.
• Risk Mitigation: Companies can safeguard client assets and reduce counterparty risks in case of unforeseen events.

Knowing your funds are securely held in a separate account, accessible only to you, offers significant peace of mind and guarantees the safety of your hard-earned money. Here are the other key benefits this type of account offers for clients:

• Transparency: Segregated accounts allow clients to track their funds and see that they are held separately from the company’s own pool of funds.
• Reduced Counterparty Risk: Separating client assets from the broker’s or the company’s offers protection against financial risks, including fraudulent activities by the company. This is especially important for traders.
• Asset Protection: In cases where the company goes bankrupt or shuts down but still has the client’s funds in holding, the debt collectors cannot pursue those funds in segregated accounts, and the assets will be returned to the rightful owners.

Important: The specific legal protections and procedures for returning assets can vary depending on the local law of each jurisdiction.

With so many benefits, segregated accounts seem like the perfect banking solution for both the company and the client. However, they might only be ideal for some situations, with some drawbacks to consider.

The first thing is the cost. Some financial institutions charge fees for opening and maintaining segregated accounts. These fees vary widely depending on the provider and location.

Another potential issue with segregated accounts is the regulatory requirements surrounding them, but this mainly concerns the company, not necessarily its clients.

Depending on jurisdictions and industries, companies may have to follow complex regulations to open segregated accounts. These may include obtaining the eligible business licence to hold segregated funds or record-keeping and reporting requirements, which can be time-consuming and incur extra operational costs.

While segregated accounts are designed to protect client funds, the complex regulations surrounding them can be challenging for some companies with limited resources.

These companies may attempt to cut corners in opening and operating segregated accounts, leading to non-compliance, mismanagement of funds, or even intentional fraud.

It isn't easy to detect because you wouldn't expect a regulated firm to do something like this, but it can happen. For example, MF Global, a regulated brokerage firm, went bankrupt and collapsed in 2011 after illicitly using its clients’ segregated funds to cover its own trading losses.

So, it is important to choose a reputable broker or company with a proven track record of compliance and transparency to make sure your money is in the right hands.

Note: Illegitimate offshore accounts can be used as a tool in segregated account fraud. Before opening one, ensure you understand how offshore banking works.

In summary, segregated accounts are opened by licensed businesses to keep client funds separate from operational funds, safeguarding them from commingling and misuse by the firm.

If you are looking for a safe way to receive and send money internationally in multiple currencies, consider Statrys.

Statrys is a licensed payment service provider offering multi-currency business accounts to companies incorporated in Hong Kong, Singapore, and the BVI. With Statrys, your money is segregated and protected through the custodian bank, DBS Bank (Hong Kong).