Securities

What are securities?

Looking for a securities definition? Securities are financial contracts, such as shares or bonds, that grant the owner a stake in an asset. They have two key features: they give certain rights to the owner; and they can be traded in the financial markets.

Where have you heard about securities?

Shares are often referred to as securities, particularly in the United States. Whenever a scandal breaks on Wall Street, you'll probably hear that the Securities and Exchange Commission has swung into action.

Share traders are also sometimes called financial securities dealers, and you'll have probably seen money advice columns in the newspapers recommend 'investment-grade securities' – that is, top-notch investments.

What you need to know about securities…

The first thing you need to know is that despite their name, securities aren’t always very secure. Stocks, for example, can go up or down according to the company’s fortunes, and you could lose, as well as gain large sums of money. Derivatives, which also qualify as securities, can be volatile. Government bonds, on the other hand, are generally considered safer, but that means they pay less attractive returns to investors.

Generally speaking, securities are a means through which commercial enterprises or municipalities (such as city councils) can raise new capital – so effectively they’re an attractive alternative to a bank loan. Companies can generate a lot of money when they go public, selling stock in an initial public offering, and state governments can raise funds for particular projects by floating a municipal bond issue. Whoever creates the securities for sale is called the issuer; and it is investors who buy them.

Types of securities

There are three main types of securities: equities, debts and hybrids:

Equity securities are shares in a company, partnership or trust. Shareholders aren’t usually entitled to regular payments – though many equity securities do pay out dividends. Instead, investors buying equity securities can profit from capital gains when they sell the securities, provided they’ve risen in value. Equity securities also give the holder some influence over the issuing company – for example, through voting rights at its annual general meeting.

Debt securities are money that’s borrowed and must be paid back at the end of a fixed term. Examples of debt securities are corporate and government bonds, collateralised debt obligations and certificates of deposit. Holders are usually entitled to regular interest payments and repayment of principal, though not to voting rights. Debt securities can be secured or unsecured.

Hybrid securities combine some of the features of equity securities and debt securities. An example of a hybrid security would be convertible bonds – bonds that can be converted into shares of common stock in the issuing company. Equity warrants are also hybrid securities – these are options issued by a company giving shareholders the right to buy stock within a specific period at a particular price.

Beyond these three main types of securities, there are some other more specialised types of securities with which you might want to become familiar:

Bearer securities – these are negotiable and entitle the shareholder to certain rights under the security. They are transferred from investor to investor, in some cases by endorsement and delivery.

Cabinet securities– these are listed under a major financial exchange, but aren’t actively traded. They are held by an inactive investment crowd, and are more likely to be a bond than a stock. The ‘cabinet’ refers to the place where bond orders were historically stored.

Certificated securities – these appear in physical paper form. Technology and policy change has done away with the need for certificates in many cases, and it’s important to note that certificated and uncertificated securities don’t confer different rights or privileges to either the holder or the issuer.

Letter securities – these are sold directly to the investor by the issuer. The term stems from the Securities and Exchange Commission’s requirement for an ‘investment letter’ from the purchaser, stating that the purchase is for investment purposes and isn’t intended for resale.

Mortgage-backed securities (MBS) – these are a controversial type of asset-backed security that’s secured by a mortgage or collection of mortgages. An MBS enables a smaller bank to lend mortgages to its customers without worrying whether the customers have the assets to cover the loan. The bank acts as a middleman between the homebuyer and the investor. Mortgage-backed securities played a key role in the 2007-09 financial crisis, and some of the legal cases arising from their improper use were only recently settled.

Registered securities – these carry the holder’s name and other details maintained in a register by the issuer. Transfers of registered securities are executed through amendments to the register.

Residual securities – these are a type of convertible security, meaning they can be changed into another form, usually into common stock. Corporations sometimes offer residual securities to attract investment capital when there’s intense competition for funds.

Market placement

Publicly traded securities are listed on stock exchanges, though electronic trading systems have developed over the years. Nowadays securities are often traded 'over-the-counter' (OTC), online or over the phone.

A company's first major sale of equity securities to the public is known as an initial public offering (IPO). After this, any other newly issued stock is called a secondary offering. But securities can also be offered privately to a restricted group – this is termed a private placement. Companies sometimes sell stock in a combination of public and private placement.

Regulation of securities

The Financial Conduct Authority (FCA) is responsible for the regulation of securitiesin the UK. The FCA says it strives to make securities markets work well by:

• Monitoring market disclosures by issuers and others and enforcing compliance.
• Reviewing and approving prospectuses published by issuers and offerors.
• Operating the UK listing regime, which requires listed issuers to comply with the Listing Rules.

There was little regulation of securities in the United States at federal level before the 1929 Wall Street Crash. But nowadays there’s an intricate web of regulatory bodies supervising the industry:

• The primary securities regulator on the federal level is the powerful Securities and Exchange Commission (SEC).
• Futures and some aspects of derivatives are regulated by the Commodity Futures Trading Commission (CFTC).
• The Financial Industry Regulatory Authority (FINRA) is a self-regulatory body that issues rules governing broker-dealers and certain other professionals in the securities industry. FINRA is overseen by the SEC, and its rules are generally subject to SEC approval.
• Brokers and dealers that are registered with the SEC, with a few exceptions, are required to be members of the Securities Investor Protection Corporation (SIPC) and are subject to its regulations. The SIPC is also overseen by the SEC, and the SIPC's rules are usually subject to SEC approval.

Find out more about securities…

If you’d like to explore this subject further, our comprehensive online glossary has lots of definitions for related terms such as shares, assets, derivatives, financial market and volatility. Take a look and develop your understanding of securities.

The Financial Conduct Authority’s website explains clearly how the regulator oversees the UK’s securities industry. Follow this link to read about the FCA’s work in this field.

The London Stock Exchange website also sets out its own rules and regulations, which you can read here.