Broker

A broker is the intermediary between an investor or trader and securities exchange. Brokers are the facilitators of liquidity in the financial system, and key players in the markets. 

Here we take a look at the broker definition in a lot more detail.

What is a broker?

A broker 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, exchange traded funds (ETFs) 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.

Key takeaways

What does a broker do?

Typically, a finance broker buys and sells financial instruments or assets on behalf of their clients. An individual who wants to trade on financial markets hence would need a broker as an intermediary between them and securities exchange. 

The broker’s role in the financial system is as a facilitator for buyers and sellers, creating efficiency and liquidity in the markets. They are essentially responsible for executing client market orders.

Traditionally, brokers communicated with clients via a phone or face to face, and offered personalised investment strategies and advice. They charged high commissions and were exclusive to high net-worth individuals. 

Yet the emergence of the digital age gave rise to online brokers, many of which are execution only. These are digital investing and trading platforms that allow clients to place trades in a few clicks, and often charge less commissions, yet may not offer specialised investment advice.

Broker fees

The fee charged by a broker or brokerage firms 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.

Broker fees would vary depending on the type of a brokerage firm, its reputation, and services it provides. 

Types of brokers

There are various types of brokers investors and traders can choose from, depending on their strategy, risk tolerance and goals. 

Investment brokers

Investment brokers facilitate the buying and selling of investments. In the UK, they must be licensed, and they charge a commission for their services. There are various subtypes of investment brokers, depending on the products they offer:

• Stockbrokers: 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. 

• Commodity brokers: A commodity broker would be offering its clients different ways of buying and selling commodities, typically via derivatives. 

• Forex brokers: Foreign exchange (forex) brokers can help traders who want to speculate on the price movements of currency pairs. 

• Bond brokers: Similarly to other types, bond brokers assist clients in buying and selling corporate and government bonds.

• CFD brokers: A contracts for difference (CFD) brokers provide traders with CFDs, which are derivative products that allow speculation on the asset’s price without owning it. CFD trading can involve leverage, which magnifies profits and losses.

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. 

Discount brokers, by contrast, usually 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. 

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 phone. 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 (GS), Morgan Stanley (MS) and Credit Suisse (CS). 

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. 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.

Broker regulation

Broker regulation would vary depending on a country in which a broker operates, and what licences it has. Typically, a country would have a regulatory body that would be responsible for overlooking brokerage firms to protect its clients from unfair practices. For example:

• US FINRA: In the US, brokerage firms are regulated with the Financial Industry Regulatory Authority (FINRA).

• UK FCA: In the UK, the Financial Conduct Authority (FCA) is responsible for regulating companies within the financial services sector.

• Australian ASC: The brokerage businesses in Australia are licenced and monitored by the Australian Security Commission (ASC).

• European ESMA: Financial firms in the European Union states are regulated by European Securities and Markets Authority (ESMA).

Note that you should always conduct your own research to have a better understanding of your local broker regulations. Make sure to use up-to-date government websites and other reliable sources. 

Brokerage examples

Let’s imagine Joanna has a full-service investment broker. Advisory services are included in her package, so after a thorough review of her portfolio needs and goals, Joanna’s broker proposes an investment plan that she approves of, and execute it.

Soon, Joanna receives an unexpected bonus at work, which she wants to invest too as a lump sum payment. After receiving advice from her broker, Joanna decides what works best for her, and makes a market order.

Another example would be a discount broker, where advisory services are not included. Let’s imagine that Michael has signed up with an online share-dealing platform and deposited his first payment into the account. When he’s decided on investment strategy, Michael makes a market order on a platform, which his online broker executes. 

Conclusion

To conclude, investment brokers are professionals who buy and sell financial instruments on behalf of their clients. They can be classified as stock brokers, commodity brokers, forex brokers, and others, depending on the instrument they provide. They also may be multi-asset brokers.

Brokers can be full-service, which means they would provide their clients with execution and advisory services, yet charge higher commission fees. Discount brokers would typically charge less, but won’t provide advice, or provide it at an additional cost. 

Meanwhile, prime brokerage services are those brokers who work with institutions such as hedge funds. 

Broker regulation varies from country to country, so it’s important to conduct your own due diligence and look into your local broker licenses. 

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