Segregated Account

A segregated account is an account, usually at a bank, that a financial firm uses to hold money belonging to its customers separately from its own money. The firm never mixes the two: operating expenses, revenue and capital sit in the firm's own accounts, while customer balances sit in the segregated account and are recorded as customer money in both the firm's ledger and the bank's records. If the firm fails, the segregation makes it possible to identify the customers' funds and return them rather than treat them as assets available to the firm's creditors.

Segregated accounts are used by payment and e-money firms, brokers, futures commission merchants, law firms, escrow agents, crypto platforms and many other businesses that hold money on behalf of others. In some regimes segregation is mandatory; in others it is a contractual or voluntary protection.

The firm opens an account specifically designated for customer funds, often titled with words such as "client account" or "safeguarding account". The bank is told, usually in an acknowledgment letter signed by both parties, that the money in the account belongs to the firm's customers. The letter typically confirms that the bank has no right to set off the balance against debts the firm owes it and cannot use the account as security for the firm's borrowing.

Most segregated accounts are pooled accounts: one bank account holding the money of many customers, with each customer's share tracked in the firm's internal ledger. A smaller number of arrangements use named accounts or virtual accounts that map individual customers to sub-ledgers at the bank. The firm must perform frequent reconciliation between its record of what customers are owed and what the segregated account actually holds, topping up any shortfall from its own money.

Several regimes require segregation:

• Payment and e-money firms in the EU and the United Kingdom must protect relevant funds under the safeguarding rules, most often by depositing them in a designated safeguarding account.
• Investment firms in the UK hold client money under the FCA's client assets rules, which require trust status, segregation and daily reconciliation.
• US futures commission merchants must segregate customer funds under Commodity Futures Trading Commission rules, and US broker-dealers must maintain a reserve account for customers under the Securities and Exchange Commission's customer protection rule.
• Lawyers and escrow agents in most jurisdictions must hold client money in a trust account.

US state money transmitter laws take a different route: rather than requiring a segregated account, they generally require the licensee to hold permissible investments at least equal to outstanding customer obligations, which the Money Transmission Modernization Act deems held in trust for customers if the licensee becomes insolvent.

Commingling, the mixing of customer money with the firm's own, is the failure segregation is designed to prevent. When funds are commingled, customers may become unsecured creditors in an insolvency and may recover only a fraction of what they are owed. Notable collapses, including the failure of the broker MF Global in 2011 and of the crypto exchange FTX in 2022, involved shortfalls in customer funds that were supposed to be kept separate.

Segregation protects customers against the firm's insolvency, but not against every risk. Funds held at a single bank remain exposed to that bank's failure, and deposit insurance may not cover customers of a pooled account individually unless the account is structured and recorded to support pass-through coverage. Segregation also depends on accurate records: a segregated account with a poor ledger behind it can still leave customers waiting months for a distribution. For crypto assets, the equivalent concept is segregated crypto custody, in which client assets are held in wallets separate from the platform's own holdings, a distinction examined closely in discussions of hosted wallets and custodial accounts.