Brokers

The Go-betweens

It is often the case that a person or organisation wants something but does not know how to go about getting that thing; where can they get it? If there are several similar things, which is best for their needs? In such situations you need a broker.

A broker is a 'go-between' between two parties. Estate agents, for example, act as brokers bringing together those who wish to sell and buy properties. However, most brokers operate in the business world.

The term broker (as a shortening of the word brokerage) can refer to an individual or also to a company. Their job is to arrange transactions between buyers and sellers. Brokers in the business world include insurance brokers, commodity brokers and stockbrokers.

Main points about Brokers:

The main responsibility of a broker is to bring sellers and buyers together. Brokers may represent either the seller or the buyer but not both at the same time.
A key part of their role is to provide information and advice to their clients, so brokers need to be very knowledgeable about the market in which they trade.
Brokers establish relationships with many prospective clients to reach the largest base of buyers and sellers so that they can get the best deals. Research is an integral part of the work they do.
Insurance brokers facilitate the transfer of risk between clients (policyholders) and insurance underwriters (those willing to take on the risk). At the centre of the insurance industry is Lloyd's of London. Currently there are over 180 accredited firms of brokers working at Lloyd's.
Commodity brokers buy or sell commodity contracts on behalf of clients in return for a competitive commission or fee.
Commodity contracts used to be mainly forward contracts for grain or metals but now cover a wide variety of derivatives (futures and options) based on an ever growing list of underlying assets. 
For inexperienced clients, full service commodity brokers provide detailed information and advice to develop a trading plan. Discount commodity brokers charge less and usually work only for more successful traders.
Stockbrokers buy and sell securities (shares and bonds). British stockbrokers work in the London Stock Exchange (LSE) which is one of the most important financial markets in the City of London.
There are two types of stockbrokers. Agency brokers buy and sell shares on behalf of clients for a commission. Dealers (or principals) buy and sell on their own account.
Dealers make their money by what is known as ‘the turn’: that is the difference between the 'bid' price (which they buy securities at) and the 'offer' price (which they sell them at). The bid-offer spread is the turn the broker makes between the two.
These days, members of the LSE are broker-dealers who deal on behalf of clients and on their own account, by undertaking to buy and sell shares in a number of companies.
All brokers nowadays work in public companies. In fact, many of them work for large investment banks that have moved into the LSE. They help broker deals for their bank's customers and find prospective buyers during issues of shares and bonds.
Smaller firms of independent brokers (known as mid-cap companies) continue in business by specialising in advising smaller companies in listing their shares, and by looking after the affairs of wealthy private clients.
Brokers rely on specialist research analysts who decide whether an investment is a good risk by analysing raw data. Their recommendations encourage institutional investors to buy and sell.
Traditionally, only the wealthy could afford a broker and access the stock market. The Internet triggered an explosion of discount brokers who allow investors to trade at a lower cost but without personalised advice. Now almost anybody can invest in the market.
Discount brokers charge a relatively small commission by having their clients perform trades via automated, computerised trading systems rather than by having an actual broker assist with the trade.
Traditional brokerage firms offer discount options and compete heavily for client volume, due to a shift towards this method of trading.
Another way they lower costs is by aggregating orders from a large number of small investors into one or more block trades, which are made at certain specific times during the day, thus reducing commissions.
 
 

The Role of the Stockbroker

The role of the stockbroker changed radically 25 years ago with an event known as the 'Big Bang'.

Before 1986 all brokers used to be agency brokers buying and selling only for clients. Trading took place in the hall of the London Stock Exchange and fixed commissions were charged on the transactions they executed. The only people allowed to buy and sell shares within the exchange were stockbrokers working on behalf of investors, or jobbers working on behalf of the listed companies. They were not allowed to buy or sell on their own account.

Essentially jobbers and brokers were members of the stock exchange and owned it. The government felt that the LSE was a cosy club, run more for the benefit of the members (the stockbrokers and jobbers) than for the investors.

If an investor wanted to buy shares in a specific company, they would go to a broker who would go to the floor of the exchange where jobbers worked. Jobbers kept a stock of shares in certain companies (made a market). The broker would go around the jobbers until they found one who had a lot of shares on their book and was therefore offering a lower price. The broker would buy them from the jobber offering the lowest price and, in turn, sell them to the investor. These members charged fixed commissions on the transactions they executed, regardless of how many shares were bought.

The 'Big Bang' saw the distinction between stockbrokers and jobbers abolished, as were the old fixed commissions; now large investments in shares could gain lower commissions. The members (who had up to then worked in partnerships) were forced to become limited companies issuing shares, so that outside shareholders could have a stake in them. Brokers could now trade on their own account and not just that of their clients.

Big banks began buying up firms of stockbrokers; share trading became computerised, and the old exchange floor went out of use. Soon the distinction between brokers and traders in banks faded, and the ability of the big banks to raise large amounts of capital for major flotations meant that these got the lion's share of the action. Also, as brokers (and their analysts) were now part of investment banks, there was a new risk of a conflict of interest arising.

For example, an investment bank might be advising a company about taking over another company. If the broking arm of the bank heard about it, it might buy the shares of the target company, knowing that the value of its shares were soon likely to rise. It thus had an unfair advantage over rival brokers. This is known as ‘insider dealing’, and is illegal. Therefore banks introduced measures (known as ‘Chinese walls’) to stop information crossing from one division of a bank to another.

The abolition of the distinction between brokers and jobbers, and the new ability of brokers to trade on their own account, also means that a broker can recommend shares to a client because he wants to sell a lot of them, rather than because they are a good investment. As a result, after Big Bang, an organisation called the Financial Services Authority (FSA) was set up to supervise the City and ensure fair trading.