Investment platforms under scrutiny over interest paid on customers’ cash

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Investment platforms are facing scrutiny from the financial regulator over the amount of interest they pay on customers’ cash deposits as they reap rewards from soaring rates.

DIY trading platforms including Hargreaves Lansdown and AJ Bell have reported bumper profits in recent weeks despite clients making fewer trades and holding smaller asset portfolios, with the windfall largely driven by interest paid by banks where they deposit customers’ money.

The Financial Conduct Authority last month wrote to platforms’ chief executives to notify them of its “immediate focus” on their retention of money made from interest payments as part of its new consumer duty policy that requires financial services businesses to provide “fair value” to customers.

The move follows an investigation into high street banks in July over accusations they were “profiteering” from customers by failing to pass on rate rises to savers while rapidly ramping up the amount charged to borrowers.

Retail investment platforms have struggled to attract new business this year as the cost of living crisis leaves investors with less money to play with. They are also being hit by a long-term shift from actively managed assets to passive index funds and competition from cheaper upstart platforms and “robo advisers”, which provide automated financial guidance.

However, the so-called fund supermarkets have still benefited from money generated on clients’ deposits.

Platforms lend client deposits to banks at the sterling overnight index average rate and pay out a lower interest rate to clients, keeping the difference between the two.

For example, an investor who holds £20,000 of uninvested cash in an ISA wrapper on AJ Bell can expect an annualised interest payment of 2.2 per cent (£440), while the platform could earn £1,040 interest on the money at the current rate of 5.2 per cent.

AJ Bell said it managed cash “over the long term using a range of terms and interest rates . . . some of [which] would have been locked in when interest rates were much lower”.

Hargreaves Lansdown last month beat analysts’ expectations with a bumper set of results after its net interest income for the previous 12 months hit £270mn, up from £50mn the year earlier. The average amount of cash across the year in its investment accounts was £14bn, only slightly up from £13.6bn the year before.

Holly Mackay, founder of consumer financial website Boring Money, said that by extrapolating from Hargreaves’ figures it was not “unreasonable to estimate” that the investment platform sector made roughly £690mn over the 12-month period from interest paid by banks on its customers’ cash.

AJ Bell said its “recurring ad valorem revenue” — its interest margin plus a 0.25 per cent custody fee on customer assets — was £75mn in the six months to March 31, up 78 per cent on a year earlier.

Interactive Investor, which is owned by Abrdn, recorded a £66mn interest rate margin in the first half of 2023, almost half of the group’s operating profit for the period.

The industry has defended its actions, highlighting that customers only hold money on its platforms for short periods and that companies typically pass on most of the benefits of rate rises while keeping customer cash immediately available.

“Over 85 per cent of the benefit of base rate rises during the past 12 months has been passed on to clients,” said Hargreaves Lansdown, adding that customers who use its “active savings” products were able to access the top rates offered by high street banks.

Interactive Investor said its cash rates were “highly visible” on its website, noting it “continually assesses treatment of interest on cash”.

“There can be plenty of circumstances where customers may maintain higher cash balances in the short term,” it added. “We think it is thought-provoking, given we are fundamentally an investment platform, that our rates do not compare unfavourably with many instant-access bank savings accounts.”

Analysts from investment bank RBC noted in September that although earnings had been meaningfully higher at the publicly listed investment platforms, their share price slide had continued.

“We have concerns that bloated revenues from this source might make profit growth more challenging as/when interest rates do eventually taper,” they wrote, noting there was also risk from regulation as the issue garners wider attention.

Hargreaves Lansdown’s share price is down 12 per cent this year while AJ Bell’s has fallen 28 per cent. Abrdn, of which Interactive Investor is just one business segment, is 13 per cent lower.

Frederic Malherbe, director of UCL’s Centre for Finance who has previously called for banks to be compelled to pass on the benefits of interest rate rises to savers, welcomed the FCA’s attention on the matter. 

“Together with some pressure to make transfer of funds in and out the platforms easier, this can only increase the competitiveness of the deposit market in the UK,” he said. “The lack thereof has cost enough to savers in the past 12 months.”

The consumer duty, a standard by the FCA, came into force on July 31 this year and requires asset managers, banks and other companies to prove that they have acted fairly and transparently and delivered “good outcomes” for customers.