The financial services authorities draw a careful distinction between investor types. This is done to determine who is eligible for consumer protection where inappropriate financial advice has been received or where an authorised investment firm has failed.
In other words, who will be entitled to financial compensation when investment outcomes go wrong.
Investor types defined by the Financial Conduct Authority
The Financial Conduct Authority (FCA) – the organisation responsible for regulating the UK financial service industry – classifies investor types between High Net Worth Investors (HMWIs) and Sophisticated Investors.
This distinction means that they are eligible to invest in certain high-risk products such as Unregulated Collective Investment Schemes (which invest in film production, forest plantations and foreign property, for example).
However, as these products are unregulated, investors will not have access to consumer protection through the Financial Ombudsman Service or Financial Services Compensation Scheme (FSCS) if the scheme fails.
What is the difference between retail investors and institutional investors?
While the FCA has clearly defined certain investor types in its Conduct of Business Sourcebook (above), it is less prescriptive on the distinction between retail investors and institutional investors. Instead, it refers to retail clients and professional clients.
The FCA defines a retail client as “a client who is not a professional client or eligible counterparty” and a professional client as “a client that is either a per se professional client or an elective professional client”.
So, it would appear that the FCA has no formal definition for either retail investors or institutional investors. However, the distinction between these investor types determines who is eligible for consumer protection.
Retail Investors:
A retail investor is an individual who buys and sells bonds, commodities, shares, Exchange-Traded Funds (ETFs) etc on their own behalf.
They trade on their own account, for their own profit (or loss) and not on behalf of financial institutions or other investment organisations.
Retail investors are private individuals and are also referred to as individual investors or private investors (PIs).
Institutional Investors:
Institutional investors are financial organisations or investment institutions such as pension funds, life assurance companies, hedge funds, private equity firms and investment trusts.
They buy and sell a diverse, complex range of investment products on behalf of their members or shareholders. They are not private individuals.
Who is entitled to investor protection?
Retail investors who suffer a financial loss following the collapse of a licensed bank or regulated investment firm in which they held a savings account or an investment product are eligible to apply for compensation through the Financial Services Compensation Scheme.
