Broker

What is a broker?

The broker definition, in financial terms, is a regulated professional who buys and sells financial instruments on the behalf of a client and charges a fee for doing so. Clients can be individual investors or companies. The financial instruments that are bought or sold can come in many forms including shares, derivatives, bonds, stocks and so on. A broker can work alone but they are usually part of a brokerage firm. Brokers exist not only in financial markets, but also real estate, commodities and even the art and antique markets.

Where have you heard about brokers?

You’ll have almost certainly heard the phrase “broker” before, whether in relation to finance or to other markets. Whenever there is volatility in financial markets, brokerage firms tend to make the news. If you have ever invested in stocks or shares, you’ll almost certainly have done this using a broker’s services. Their role as a facilitator for buyers and sellers make them very important people in the financial system, creating efficiency and liquidity in the market. The fee charged by a broker or brokerage firm is often commission based and usually based on a percentage of the customer’s sale price or purchase, though some brokers receive a flat fee for their services, or a combination of the two.

What you need to know about brokers…

As agents of their clients, brokers have an obligation (not to mention a financial incentive in the form of commission) to get the best possible price for the assets that they are trading. Numerous professional designations exist for brokers, depending on the kind of licence they have, what kind of financial instruments they trade in or the services that they provide.

Different countries have different requirements and regulations on brokers. In the UK, a person wishing to become a broker must complete an officially recognised qualification from the Financial Conduct Authority (FCA). There are a number of appropriate qualifications on the FCA’s list and which one a trainee will undertake depends upon their duties and their employer. In the US, there are several different exams that one must take to become a properly licenced stockbroker, and these are done through the Financial Industry Regulatory Authority (FINRA).

A history of brokers

The first recorded instances of semi-organised stockbroking occurred in Rome around the time of Julius Caesar in the 2^nd century BC. After the collapse of the Roman Empire, some 600 years later, stockbroking disappeared with it. That is, until the Renaissance came along. This was not just a renaissance in art, science and literature, but also in finance. Mercantile cities such as Venice, Florence and Genoa in today’s Italy began trading government bonds. Around the same time in Northern Europe, there were instances of trading shares in mines and ships as a means of risk diversification.

The world’s oldest, still-functioning stock exchange can be found in London. The London Stock Exchange (LSE) traces its roots back to “Jonathan’s Coffee Shop” in 1698. It was here, in this renaissance-era Starbucks, that rich clientele with money and time on their hands would trade things and share information. After 75 years at Jonathan’s, the brokers (as they would later be known) pooled resources and constructed a building which would become the LSE. In 1801, the LSE became a fully regulated stock exchange and in 1923, as proof that the brokerage trade had fully entered the establishment, it received its very own Coat of Arms from the British Monarchy.

The oldest etymology of the word “broker” is somewhat disputed but it is can be traced back to Middle English, from the Anglo-Norman French word ‘brocour’, which denotes a retailer or pedlar.

Investment Brokers

Investment brokers are people who facilitate the buying and selling of investments. In the UK, they must be licenced, and they charge a commission for their services. A stockbroker is just one of several types of investment broker and probably the best known. As the name suggests stockbrokers specialise in the buying and selling of stock. The main other types of investment broker include:

• Full-service brokers
• Discount brokers
• Prime brokerage

Full-service vs. Discount brokers

As an investor, the choice between a full-service or discount broker is an important one. The traditional, full-service brokerage firms do more than simple facilitation. These companies will also offer their clients a wide range of products and services based on personalised advice and recommendations that are based around an understanding of your needs as an investor as well as a deep knowledge of your existing portfolio. The other services include such things as retirement and financial planning, investment and tax advice as well as portfolio reports and updates. Naturally, when receiving a bespoke service like that of a full-service broker, the fees are usually higher, often around 1%-2% on the assets managed. So, the fees on a portfolio of £200,000 would cost around £2,000 to £4,000 annually. Full-service brokerage firms are something worth considering, especially when investing and when planning for retirement. Also, if you’re not confident investing on your own, then the guidance and personalised advice of these more traditional brokers may be the best option.

Discount brokers, by contrast, are a better choice for those less willing to pay the fees and more willing to take the risk of going it alone. Usually discount brokers don’t offer any advice regarding investments, though many will offer access to educational tools and research aids to help their clients make better informed investment decisions. These kinds of brokerage firms come in various shapes and sizes. Some are only online, others have physical offices. In general, the higher the fee the better quality educational tools on offer. Usually discount brokers ask for a small commission on each sale and purchase and some ask for annual fees, though this is less common. Trading is done either online or by telephone. Discount brokers are a good option for those looking for something lower cost or those who want to go it alone. Some of these brokers will offer their clients personalised advice for an additional fee.

Prime brokerage services

Prime brokerage is the general name given to a group of services that brokerage firms and investment banks provide to important or special clients. All the big players in brokerage and banking offer these services, including Goldman Sachs, Morgan Stanley and Credit Suisse. The necessity for prime brokerage arose from the growth in hedge funds. This rapid rise created a need for an intermediary, who would cater for the complex and difficult operations that are necessary for hedge fund management. Working in a largely unregulated sector of the financial industry, prime brokers cover the specific requirements that arise from large portfolios and certain brokers offer a more specialised service to their clients, depending on their needs and requirements.

Prime brokerage packages can include:

• Financing
• Securities lending
• Customised technological software and hardware
• Custody of assets
• Operational support
• Risk management

Essentially, prime brokerage services offer large institutions a tried and tested mechanism through which many of their day-to-day investment activities can be outsourced, enabling them to focus on investment strategies and goals.

Prime brokers typically claim fees, or spreads, on their financing of the long and short positions of their clients’ investments, as well as from charging for clearing and other services.

Find out more about brokers…

The Financial Times have a handy guide entitled “How to choose a stockbroker” which offers plenty of great advice on the stockbroking industry in the UK.