What do brokerage firms do?
Broking involves acting as an intermediary between a buyer and a seller, bringing the two together to execute a transaction. This is necessary as those involved often want to maintain anonymity from the rest of the market. Although some brokerage firms may offer other services in addition to corporate broking, brokers are generally limited in what they do: they don't trade on their own behalf, offer investment advice or attempt to raise capital of their own.
How do they operate?
Broking transactions are performed in three different ways: voice, electronic and hybrid. Voice broking takes place over the phone, with dealers speaking directly to various clients in order to negotiate deals. This is the traditional method of brokering deals and, although technical advances have seen a rise in electronic broking (buyers and sellers being matched by computer), voice broking continues to be responsible for the majority of revenue in the industry.
Whether a transaction is performed using voice or electronic broking is determined by what's being traded; electronic broking is best suited for standardised markets (for example, foreign currency exchange) while voice broking is used for less liquid markets that require more negotiation (for example, credit derivatives). Hybrid broking combines the benefits of both these forms of broking, allowing clients to take advantage of electronic efficiencies while receiving the bespoke service of voice broking.
Who are the clients?
The traditional clients of brokerage firms are traders at investment banks and other trading houses. Many of the larger firms have begun to offer a wide range of post-trade services, which has expanded their client base to other finance firms. Some have also taken advantage of the fact they process large amounts of financial data, and have monetised this by selling it to data providers like Reuters and Bloomberg.
How do the firms make money?
As brokers don't trade on their own behalf, money is instead made by charging a commission on every deal they facilitate. This is supplemented in some cases by the sale of financial data (see above) and the provision of post-trade services that aim to reduce the risk in a client's portfolio.
Why should I be interested in it?
A career in broking is ideal for anyone who has a keen interest in financial markets but isn't convinced they want to work on the trading floor of an investment bank. Clients will use the same broker repeatedly so an important part of the work involves building relationships with other people in the financial sector. Those with an ability to manage client interactions and understand the nuances of the market will be well suited to life as a broker.
Markets operators ICAP is one of the leading global interdealer brokers, with an average daily transaction volume of $1.3 trillion (£813 billion). In addition to its broking services, ICAP also offers a wide range of post-trade risk mitigation services, enabling clients to reduce their exposure to risk.
Formed in 1945 as both an investment bank and brokerage business, Cantor Fitzgerald was at the forefront of developments in electronic broking. Its business was severely hit by the terrorist attacks on 9/11, due to their corporate headquarters being located on five floors of one of the World Trade Center towers. Despite losing over two-thirds of its workforce, the company was able to bring their trading markets back online within a week.
Tullett Prebon was founded in 1971 as a foreign exchange broker by Derek Tullett. Following a string of mergers, the firm now operates as an intermediary in wholesale financial markets. In 2012, they produced revenue of £850.8 million and were asked by the Financial Services Authority for assistance in investigating the LIBOR interest rate fixing scandal. The company also has several specialist trading desks.
Bid The price at which a broker offers to buy a security from a trader on behalf of a client.
Bid-offer spread The difference in price between the bid and the offer, and a measure of the liquidity of that security.
Liquid Used to describe markets where the price of a security varies little and trades can be executed quickly.
May Day Rather than the one which occurs every year, this refers to 1 May 1975. On this day, brokerage firms switched from charging their clients a fixed commission to a negotiated one, a move which led to the rise of discount brokerages.
Name give-up brokerage In this model of brokerage, buyers and sellers remain unknown to each other until the point where an agreement is reached and a transaction is completed.
Offer The price at which a broker offers to sell a security to a trader on behalf of a client.
Trending in brokerage
In the wake of the financial crisis, the regulatory environment has changed dramatically. As a result the broking market has been overhauled, with clearer rules put in place on how clients can engage with their brokers and with electronic platforms. Brokerage firms have also had to ensure that their modes of executing trades comply with the latest regulations.
More electronic trading
Increased regulation is also likely to drive more broking activity towards electronic platforms as this is easier to monitor. While brokerage firms will continue to argue for the importance and relevance of voice broking, markets with sufficient liquidity are likely to fully shift to electronic trading to appease regulators.
The rise of payday loan companies has had an impact on the brokerage industry, as large broker networks are required to generate business. Some companies that advertise payday loans are actually brokers themselves, meaning applicants have to pay a broker fee (payable upfront) regardless of whether their loan application is successful. Other brokerage firms have moved in the other direction and offer applicants assistance with avoiding these extra fees.
Did you know...?
Made In Chelsea star Spencer Matthews used to work for market operators ICAP as a Forward Foreign Exchange Broker before the "reality" TV show became a full-time concern.