Stock exchanges are not what they once were – and that may be no bad thing. Stock exchanges used to be clubby institutions, dealing mainly in the shares of domestic companies and largely protected from competition. That meant that the people who ran the club could dictate what clients paid for their services and the terms and conditions that they applied. No longer. Today’s major exchanges are run more as businesses, increasingly competing with each other and increasingly responsive to the demands of their major clients. With the growth of international securities trading, no exchange can rest on its laurels and assume that it has permanent access to a captive clientele. If it does not give the clients what they want, the chances are that some other exchange will. There is no God-given rule that says that shares of British companies may be traded only in Britain or of French companies only in France.
But the change is not without its problems. The ideal market (and a stock exchange is only a market) brings together all prospective buyers and sellers of the product, allows the price of the product to be determined by the interplay of all these buyers and sellers, and ensures that this mechanism for establishing prices is transparent and visible to all. If you split the buyers and sellers between competing markets, you may find that the mechanism for establishing prices comes under threat.
This is less of a problem than it once was, however. The growth of electronic communications has revolutionized the picture. Stock exchanges used to be physical marketplaces where buyers and sellers (or their agents) came together on a trading floor. Today, computers have increasingly replaced the trading floor. A computer with electronic links to the market’s clients can bring together the orders of all would-be buyers and sellers more efficiently than any physical marketplace. Moreover, it does not matter where these clients are physically located. Provided they can tap in to the market via computer and telephone line or satellite they can participate in the market as easily as an investor located on the market’s doorstep.
The next question will be: do we even need formalized markets, operating their own proprietary computer systems? The Internet provides a resource available to anyone with a telephone and a computer that potentially can bring together buyers and sellers of anything from anywhere on the globe. What the Internet cannot provide, however – or not yet, anyway – are the rules, regulations and supervision that established markets operate for the protection of their users. So the initial impact of the Internet has been as a medium for disseminating information on the established stock exchanges and the stocks and shares that are traded on them. It also provides a channel of communication for would-be buyers and sellers of shares to place orders. But the orders, at least in the initial stages, are being executed on the established markets.
Where does the London Stock Exchange (LSE) fit into this evolving picture? At the end of the 1990s it was the only stock exchange in Britain with which the general public was likely to come into contact, though technically it was not the only stock exchange. And it had changed and evolved mightily over the previous 20 years. Gone was the old trading floor off Throgmorton Street in the City of London where dealers had once met face to face. It had long been replaced by a central computer linked by telephone and further computers to the dealing rooms of the individual brokers and securities houses. Share purchases and sales took place over these telephones and computer links between the individual dealers’ offices. Visitors to London who ask to see the stock exchange are invariably disappointed. There is nothing much to see. The closest they can get is to arrange a visit to the screen-studded dealing room of one of the market’s major players.
The LSE has evolved in its scope as well as its technology. In terms of size, London ranks after the New York Stock Exchange (NYSE), the American Nasdaq computerized exchange and the Tokyo Stock Exchange. But in addition to its business in domestic shares it has also become the largest market for trading in international equities.
But even these changes are dwarfed by the proposal that surfaced in the year 2000: a full merger between the LSE and the German stock exchange, Deutsche Börse. A new company would be formed, half owned by each party and called iX (for International Exchanges). It would be based in London but with major operations in Frankfurt: notably the new market for high-growth technology stocks which was to be run as a joint venture with the American Nasdaq. A new electronic trading platform for all cash markets in the new grouping, known as Xetra, was also proposed. The new grouping would also include the Continental European Eurex derivatives market. In due course other European exchanges were expected to join iX in the push towards a true pan-European securities market. Initial reports that all trading might be in euros – even for the shares of British companies – caused some consternation in the UK. But it was later suggested that the trading currency would be the one which most suited the needs of investors and other market users and sterling prices would, in any event, continue to be available for private investors.
It will be some time before the full implications of the proposed merger – and the new trading platform – are apparent. In the meantime the London Stock Exchange has already evolved in terms of its trading methods. Twenty years back stock exchange members were divided between jobbers (marketmakers or principals) and brokers (agents) in what was known as a single-capacity system (we will explain what this meant in a moment). Both classes of stock exchange members had to be independent entities – they could not be owned by banks or other institutions.
In what came to be known as the Big Bang changes of the 1980s, this single capacity system was abandoned in favour of a system where firms could act both as marketmakers and as agents, and could also be owned by large financial institutions. It was at roughly the same time that trading moved from the physical marketplace of the stock exchange trading floor to a computer-and-telephone system.
Some eleven years further on, in 1997, yet another trading system was introduced for the shares of the largest companies. Buy and sell orders could be posted direct on a central computer, which would automatically execute matching trades.
Finally, the London Stock Exchange has changed greatly in terms of its membership. There are still independent brokers acting only as agents for investors. But most of the larger stock exchange member firms have been taken over by big financial institutions, mainly retail or investment banks from Britain or abroad. At the same time, established overseas financial institutions, particularly the American investment banks, have become members of the LSE. The biggest of these groupings form major securities houses which offer the whole range of financial and investment services, including marketmaking, agency brokerage, organizing and underwriting of securities issues, eurobond dealing, money market and foreign exchange services, and so on. The corporate finance arms of the investment banks also orchestrate companies’ takeover bids and bid defences and advise on anything concerning financial structuring. There may also be a large fund management operation, managing investments on behalf of clients (particularly the pension funds). Finally, the bigger brokers and securities houses employ large numbers of investment analysts who research the economy, the financial markets and the prospects for individual companies. The research is structured mainly as a service to the investing institutions whose stock exchange business the firm is anxious to secure. But investment analysts are also a prime source of information for financial journalists, and you will see their forecasts referred to frequently in the press.
The current structure of stock exchange member businesses poses some problems with terminology, particularly for financial journalists with memories of the pre-Big Bang days. Journalists often tend to talk of brokers and refer to them by their original names even when they are now part of a larger grouping. But the term securities house has gained ground when referring to the large concerns. Marketmaker is normally used when referring to the specific function of making a book in shares.
The London Stock Exchange used to be a mutual organization, owned by its members. But this, too, neeeded to change for ambitious plans such as the iX merger to be practicable. Hence the plan to allow its shares to be transferable, thus breaking the link between usage and ownership of the exchange.
But before looking in more detail at recent developments we need to set the London Stock Exchange – as it exists today – in context with a few facts and figures. First, like most stock exchanges, it is both a primary market and a secondary market. It is a primary market in which securities may be sold for the first time to the investment community to raise cash for businesses. And it is a secondary market in which existing securities may be bought and sold between investors. The LSE’s domestic market also breaks down into two main parts. There is the market in company shares, known as the equity market. And there is the market in bonds which is known as the fixed interest market or the gilt-edged market (after the British government bonds or gilts which are its main constituent). But the range of securities that are dealt is wider than this. As well as ordinary shares in British companies there are shares in overseas companies listed in London, preference shares and more esoteric pieces of paper such as warrants and covered warrants. The market in traded options used to be part of the LSE but is now amalgamated with Liffe (the London International Financial Futures and Options Exchange – see Chapter 18). On the fixed interest side there are convertible loan stocks and straight fixed-interest bonds issued by companies (these may also be known as industrial debentures, industrial loans or corporate bonds). And as well as UK government bonds, loans issued by local authorities and certain bonds issued by overseas governments are also listed. Bonds issued in the euromarket may also be technically listed on the LSE.
The total value of shares listed in the market – £1,820 billion at end 1999 for domestic companies listed on the main market in London – is known as the equity market capitalization. The value of the annual turnover in shares was £1,385 billion for UK equities in 1999 and the number of bargains (a stock exchange transaction is called a ‘bargain’, whatever price you pay!) was 20.1m. Both figures included some trading that was purely between dealers, rather than with the public. In addition to its business in domestic shares, we have seen that the London Stock Exchange is the largest market for trading in international equities, using an electronic price quotation system called SEAQ International. Shares in any company listed on a stock exchange approved by the London Stock Exchange can be traded via this system. The total value of trades in 1999, at £2,420 billion, was considerably larger than that in domestic shares.
As a measure of the LSE’s function as a primary (capital-raising) market, in 1999 some £14 billion was raised by the first-time sale of shares by new or existing UK companies and the figure rises slightly if domestic company bonds and other securities are included. But for bonds the domestic market is dwarfed by the euromarket or international market. In 1999 listed UK companies raised over £82 billion by the sale of eurobonds formally listed on the London market, though trading in these bonds is outside the domestic market (see Chapters 13 and 17).
As we noted earlier, the London Stock Exchange comprises more than one market. Companies that are listed on the stock exchange make up the main market, which is by far the most important component. The ‘listing’ refers to a Listing Agreement that companies have to sign, which governs aspects of their behaviour and their reporting to shareholders. Though the LSE has traditionally been the Listing Authority for UK companies wishing to market their shares, responsibility for this function is due to move to the Financial Services Authority (FSA). At the end of 1999 there were over 2,000 domestic listed companies. In addition, the shares of many overseas companies are listed on the London exchange as well as in their country of origin.
The Alternative Investment Market or AIM, which the stock exchange runs in addition to the main market, is designed for the shares of younger or smaller companies which might not qualify for a full listing. The idea, in catering for the funding needs of developing companies, is to keep the costs down and make the rules as simple as possible. As well as catering for complete market newcomers, the AIM market was intended to provide a facility for companies whose shares were previously dealt under the stock exchange’s Rule 4.2. This allowed dealing on a matched bargain basis (see glossary) in shares of companies that were neither listed nor quoted. The AIM companies, close to 350 of them at the end of 1999 and with the number rising sharply, do not fall within the definition of listed companies. Their shares may be described as being quoted or traded on the market.
Figure 6.1 Stock exchange volumes in UK equities The second half of the 1990s proved a boom time for the London Stock Exchange, as well as for those who invested in the market. Strongly rising share prices were matched by rapidly increasing turnover on the market, both in value terms and in terms of the number of transactions (‘bargains’). Our chart shows the volume for shares in UK companies listed on the main market and includes some trading between market members. Source: Office for National Statistics: Financial Statistics.
This is not the stock exchange’s first foray into the world of smaller companies. In 1980 it launched a second-tier market called the Unlisted Securities Market or USM, which has now been wound down. And for even more embryonic companies it had opened in 1987 an earlier version of a small-company market known as the Third Market. But this proved short-lived, closing after a few years.
While the LSE’s AIM has filled a need, most ‘junior’ markets face a common problem. Cut back too far on the regulation and scandals erupt which damage the credibility of the market. Step up the regulation and the costs deter companies from joining. There is also a perennial problem in stimulating sufficient trade in the shares of small companies to ensure a reasonably liquid market.
There is one other market within the stock exchange that we should mention as you are likely to read a lot about it in the future. This is techMARK, announced towards the end of 1999. Technically, it is not a separate market but a grouping of technology companies within the main market, which will have rather different listing rules from those applying to the majority of companies (see Chapter 8). It also has its own indices.
The London Stock Exchange is not the only organization that has provided share trading facilities in Britain. There used to be a freewheeling and unofficial Over-the-Counter or OTC market, conducted over the telephone by licenced dealers in securities. Regulation was minimal, it was not part of the LSE and the LSE did not like it. It was pretty much killed off by the Financial Services Act of 1986 which made life very difficult for a marketmaker who was not part of a Recognized Investment Exchange or RIE – the London Stock Exchange is, of course, an RIE. Today there is an unregulated share trading facility outside the LSE called OFEX which facilitates dealing in small companies that are not listed or traded on the LSE, but that might previously have been dealt under Rule 4.2. ‘Indicative’ prices for shares in these companies are listed in the Financial Times. OFEX is not a Recognized Investment Exchange and it is not technically even an exchange. But it does operate under the aegis of an LSE member company.
Despite encouragement for the private investor from privatization issues and from the distribution of shares by former mutual building societies, today’s stock exchange is dominated by the financial institutions. In the 1950s private investors owned more than 60 per cent of all shares directly. By 1997 their holdings represented less than 17 per cent of the total. Institutions (mainly the pension funds and insurance companies) owned around half of all shares in 1997, against some 30 per cent in the 1960s. But, reflecting the internationalization of securities ownership and trading, foreign investors have been the fastest-growing category in recent years, with 24 per cent of the London equity market in 1997 against only 7 per cent in 1963.
When it comes to trading volumes, private investors are still less significant than they are in terms of ownership. Though their deals account for a high proportion of all individual trades, this is misleading since their bargains tend to be small. Their deals accounted for under 7 per cent of the total in terms of value, according to a survey in 1999. Because their bargains are small, private individuals overall tend to pay average commission rates several times those paid by the institutions in percentage terms. But though percentage commission rates on big institutional deals are much lower, the actual commission earned may be much higher and it is not difficult to see where the market perceives its best interests. Large institutional deals are not necessarily more expensive to undertake and process than the small private-client deals and can therefore be vastly more profitable.
Figures for share ownership in Britain can therefore convey a very distorted picture of investment activity. Thanks largely to privatization issues and the arrival on the stockmarket of former building societies, the number of individuals owning shares directly rose from around 3 million in 1980 to a peak of over 14 million or so in 1997 and slipped back to around 12 million in 1998. But a majority of these shareholders own small amounts of shares in one or two privatization stocks or former building societies, rarely if ever use a stockbroker and are largely irrelevant to stockmarket activity. The organization ProShare, which exists to promote share ownership, estimates that less than half of all shareholders own shares in two or more companies. The number of active or substantial private investors is probably numbered in the hundreds of thousands rather than the millions.
Twenty years ago, when a private investor – call him Joe Bloggs – wanted to buy 1,000 shares in ICI, he contacted his stockbroker with the order. The stockbroker or a member of his staff on the stock exchange floor went round the pitches (trading posts) of the various jobbers (marketmakers) who dealt in ICI shares till he found the one offering the best price. He bought the 1,000 ICI shares from the jobber and his firm’s back office operations looked after the subsequent paperwork which was necessary to transfer the shares into Joe Bloggs’s name. The jobbers acted as principals, buying and selling shares on their own account and hoping to make a profit in the process. They could deal only with brokers or with each other, not direct with the public. The broker, on the other hand, operated as an agent and could deal only with a jobber on behalf of his client, not direct with another broker. He was remunerated via a commission calculated as a percentage of the value of the transaction. Minimum commission rates were set by the London Stock Exchange and they operated on a sliding scale. The percentages were higher on small transactions, reducing on the large institutional trades.
This single-capacity system with two distinct classes of stock exchange member – jobbers acting only as principals and brokers only as agents – claimed a number of advantages for itself. Competition between the different jobbing firms would, in theory at least, ensure competitive pricing of shares. The presence of the jobber as marketmaker promoted a liquid market: one in which transactions could be undertaken easily without moving the share price too violently up or down. Since the jobber was always there to act as buyer or seller as required, a Joe Bloggs or his broker did not have to wait until a Bill Smith turned up wanting to sell 1,000 ICI shares before the transaction could go through. The jobbers would sell to Joe Bloggs and subsequently buy from Bill Smith when he emerged. But the system was also expensive. The jobber quoted two prices: a higher price (the offered price) at which he would sell and a lower price (the bid price) at which he would buy. The difference between the two was known as the spread or turn. Add the cost of the jobber’s turn to the relatively high commission to the stockbroker and share dealing was not cheap. In the late 1970s there were signs that some institutional business was moving to the more liquid New York Stock Exchange, which had already abandoned fixed commission rates. This ultimately helped to spark changes in London.
As far as the private investor is concerned, however, the share dealing process – or the part of it that he can see – is not all that different today. He still approaches a broker to buy or sell on his behalf, though it could be a broker that he contacts via the Internet. But behind the scenes a great deal has changed. It happened like this.
In the first half of the 1980s the UK government threatened legal action against the London Stock Exchange unless it abandoned its restrictive practices, notably the fixed minimum commission structure. In the end the exchange bowed to the pressure and a deal was struck. It would abandon its fixed commissions in favour of negotiated commissions. But at the same time brokers, who foresaw a big drop in their income, insisted on the right to operate as marketmakers to try to recoup some of the shortfall. Thus the single-capacity system broke down. All stock exchange members would be able to elect to operate as marketmakers, with a duty to make a continuous market – be prepared to deal at all times during trading hours – in the shares in which they had opted to deal. Alternatively, they could operate as broker dealers, who could supply clients with shares that they held on their own books provided that the shares could not have been bought more cheaply from a marketmaker, but who had no obligation to make a continuous market. Both types could also act as agency brokers (like the old style stockbrokers), executing clients’ buy and sell orders with the marketmakers and charging a commission (though in theory a negotiated commission) on the deal. Some brokers, particularly smaller ones, chose to confine themselves entirely to this agency role.
Accompanying these changes was another significant development: the abandonment of the rule against outside ownership of stock exchange firms. The partners of most of the big jobbing and broking firms were only too ready to sell out to the banks and other institutions that beat a path to their doorstep with pockets overflowing with cash, and many of them retired happy and rich. It was pretty clear at the time, and abundantly so with the benefit of hindsight, that most of the buyers overpaid vastly for what they were getting. But at least the presence of new owners with deep pockets added welcome liquidity to the market – it takes a great deal of cash for marketmakers to hold large stocks of shares on their books.
The most significant of these changes to the exchange’s structure took place on 27 October 1986 on what was known as Big Bang day and the new players had roughly a year of buoyant share trading before Nemesis struck in the shape of the stockmarket crash of October 1987 (see Chapter 7b). Share-dealing volumes plummeted thereafter and took years to recover. Many of the new owners of stock exchange firms were forced to cut back their operations or abandoned the stock exchange altogether.
The post-Big Bang trading system relied heavily on computers once face-to-face dealing had been abandoned. At the heart of the new structure was a computerized system called SEAQ (Stock Exchange Automated Quotation System), into which marketmakers fed the prices at which they were prepared to deal. This was planned initially as a price information system rather than an automated dealing system. The dealer used the SEAQ screen to see who was offering the best price in the stock that interested him. He then phoned the chosen marketmaker and arranged the deal. The rule was that the marketmaker must be prepared to deal up to a certain stated number of shares at the price he had quoted though he could, of course, adjust his quoted prices after he had done the deal. With larger deals above this stated number, the deal was subject to negotiation. In 1989, a fully automatic system for executing small transactions was introduced under the name of SAEF (SEAQ Automatic Execution Facility).
While the principle of the London marketmaker system was competition between marketmakers in all shares, this proved unrealistic in the case of some very small or infrequently traded companies. For these there might be only one marketmaker or there might be no marketmakers quoting continuous prices. Here, a system called SEATS (Stock Exchange Alternative Tracking Service) displayed the marketmaker’s quote (if any) and firm orders from member firms.
Marketmakers, brokers and some big institutional investors all had SEAQ screens in their offices. The screen showed them the marketmakers who were offering the most favourable prices in the share they were interested in at the given time. Big institutional investors with SEAQ screens in their offices had the option of dealing direct with the marketmakers at net prices, thus cutting out the agency broker and saving his commission. Small private investors needed, of course, to go via a broker.
Thus, following the Big Bang, the London Stock Exchange still had a quote-driven trading system (marketmakers quoted prices at which investors could choose whether or not to buy or sell). But the market players – or many of them – had changed and computers had replaced face-to-face trading. The next major move came in 1997 and involved the introduction of a totally different order-driven system (described as an Order Book Trading system), initially for the 100 most actively traded shares that constitute the FTSE 100 (Footsie) Index, plus a few others. The number of shares covered by the system was subsequently extended and is likely to increase further. But for the moment the new system runs alongside the marketmaker system for these actively traded shares while the less actively traded shares are dealt through the marketmaker system alone. The new system is called the Stock Exchange Electronic Trading Service or SETS. The big difference between SETS and the marketmaker system is that buyers and sellers are matched directly without the need for the trade to go through a middleman. They are also matched by a computer which can execute the trades rather than acting merely as a SEAQ-type, price-information system.
SETS works like this. An investor wants to sell, say, 100,000 shares in Payola Properties at a price of 200p or higher. His broker enters the sell order onto the SETS computer. If there happens to be an order already on the computer from an investor who wants to buy 100,000 Payola shares at 200p or less, then the computer can match the two trades immediately. The 100,000 shares are sold by one investor and bought by another and, since they have been satisfied in full, both orders can then be removed from the system.
In real life, things are rarely as neat as this. More likely is that one investor wants to sell 100,000 Payola shares at 200p or above and another investor wants to buy 60,000 Payola shares at a price not above 196p. The computer cannot match the orders and a trade cannot take place unless the seller decides to lower his asking price or the buyer raises the price he is prepared to pay (or other buy and sell orders at different prices are put on the system). Assuming seller or buyer (or both) adjust their prices to arrive at the same figure, the computer can then execute the trade, but not in its entirety. The seller wants to dispose of 100,000 shares, the buyer only requires 60,000 shares, so the buyer’s order can be satisfied in full and will be removed from the system. The sell order will remain on the computer but be reduced in size from 100,000 to 40,000 shares.
We have taken the example of a single buyer and a single seller, but in practice numerous buy and sell orders in each of the shares traded through the SETS system may be entered throughout the day. An investor using the system (via his broker) has several options. He may:
• ask his broker to execute his order at best. This means that the order is to be executed immediately at the best price available on the order book computer at the time;
• give his broker an execute & eliminate order. This works rather like the ‘at best’ order, with the difference that the investor sets a price limit. The order will be executed wholly or in part only if this is possible at the specified price or better;
• give his broker a limit order. This means the buyer or seller specifies the price at which he is prepared to deal, how many shares he wants to deal in and a time and/or date when the order should expire. The order is put on the computer and executed immediately in full or in part if this is possible at the stipulated price. If not, the order remains on the order book until either it can be executed or it expires, at which point it is withdrawn;
• give a fill or kill order. In this case the order will be executed only if this proves possible immediately and in full. Otherwise, the order is removed from the order book.
The SETS system has not been completely problem-free in its early days. In particular, buyers and sellers may enter unrealistic prices, especially at the start of a day’s trading when volume is thin. This may give a misleading impression of the true price level and persuade some investors to deal at unrepresentative prices. Steps were taken to mitigate this problem and soon virtually half by value of the trades in shares on SETS was being executed through this system with the remainder going through the older marketmaker system. Shares in companies not traded on SETS go through the marketmaker system as before. Marketmakers may, of course, themselves intervene to buy or sell shares via SETS when they see the opportunity of a profit.
Private investors who always need to place their orders via brokers are somewhat removed from the mechanics of the dealing system and will not always have been aware of the introduction of SETS. For them, the two most noticeable changes of recent years are the abandonment of the old stock exchange account system and the introduction of a new settlement system.
In the past, the stock exchange’s year used to be divided into two-week accounts (with the occasional three-week account at bank holiday periods). The usual account thus ran from the Monday of one week to the Friday of the following week. Anyone buying or selling shares during this period did not have to pay for the shares or deliver the shares he had sold until settlement day or account day, which was ten days after the end of the relevant account. A speculator could thus deal for the account. If he bought at the beginning of the account and sold before the end, he would never have to pay for the shares. He would simply receive or pay a cheque for his profits or losses. Trading in gilts, however, was and remains for cash settlement (in practice this means payment the day after you buy the stock). The old equity account system has now disappeared and been replaced by a system of rolling settlement. In 1999 the settlement period was down to five days, which meant that a buyer would normally have to pay for shares or a seller would have to deliver shares five days after the trade took place, and there were plans to reduce it further to three days.
After shares have been bought or sold, settlement must take place. This is the process of confirming the deal, collecting cash from the buyer, recording the change of ownership, and so on. It is part of the back office function in a broker’s office. The big change in this area is the introduction of an electronic settlement system called CREST. To understand its impact we need to look at the old system first.
When an investor bought or sold a share, he was sent a contract note which gave details of the transaction and payment became due on settlement day. Once the contract note had been sent, the broker dealt with the subsequent paperwork – and the system used to be largely paper-based, even if computers were used to generate the paper. Purchases and sales had to be registered with the company whose shares were involved and the company eventually issued a share certificate to the new owner. British company shares are thus registered securities (though the identity of the real owner is sometimes cloaked in a nominee name). It is a Companies Act requirement that a company keep a register of shareholders, and the public has the right to inspect the register on payment of a fee. In some countries shares in bearer form are more common. The certificate alone is proof of ownership, which does not have to be registered with the company.
This system of share transfer, coordinated through a stock exchange computer system called Talisman, was lengthy and time consuming. Talisman has now been replaced by the more efficient CREST electronic system for most shares. Shares within CREST are held in electronic form and the beneficial ownership can be transferred from a seller to a buyer with a few clicks of the computer keyboard. The lengthy paper-based process is cut out.
The concept of an electronic share registry is difficult to grasp at first encounter, so let’s start from the principles. As noted earlier, shares may be held in the name of a nominee company rather than in the name of the beneficial owner. This is a convenience often used by investment managers who hold shares for a number of different investors. The shares owned by these investors legally belong to a nominee company run by the investment manager: call it Whoopee Nominees Ltd. There might be, say, 100 different investors whose shares are held by Whoopee Nominees. In the registers of the companies whose shares are held by the nominee company, Whoopee Nominees will appear as the registered owner. However, the people who really benefit from the ownership of these shares are the investors on whose behalf Whoopee Nominees holds them. They are the beneficial owners, though not the registered owners, and have the right to receive dividends and proceeds from sale of the shares. The advantage for the investment manager is that shares may change hands between the investors within the nominee without each change of ownership needing to be registered in the shareholder list of the company concerned. If Mr Smith and Mr Jones are both clients of Whoopee Nominees and Smith sells 1,000 Payola Properties shares to Jones, Whoopee Nominees remains the owner of these shares as far as Payola is concerned. Only the beneficial ownership has changed.
This is the principle behind CREST. A large number of financial institutions and brokerages run nominee accounts in CREST in which the shares that are beneficially owned by their clients are held. The nominee company is thus the legal owner. The shares are held as electronic records rather than as pieces of paper. If one investor sells a share and another buys it, only the electronic records need to be amended. It is rather like the electronic message that would be sent if you and I used the same bank and I transferred money from my bank account to yours. Of course, as in banking, a clearing system is needed when shares are transferred from one institution’s nominee account to that of another, and CREST provides this; it ensures that the seller or buyer is never out of both stock and cash during settlement.
In practice the system is more complex than this and investors have a choice. The shares they own can be held in a nominee account run by, say, their stockbroker. The advantage here is that they do not need to bother with share certificates and when they buy or sell shares the transfers can be registered electronically, which reduces dealing costs. The disadvantage is that they will not automatically receive annual reports and other communications from the companies they invest in. These will go to the nominee company as the legal owner of the shares. And votes in company affairs will be exercised by the nominee company rather than by the individual investor. However, the ProShare organization set up to encourage share ownership does promote a system whereby investors may receive annual reports even when their shares are held in a CREST nominee account. Many stockbrokers pass on benefits and voting rights to their beneficial shareholders – you should talk to your stockbroker about the services he offers.
A second option for the investor is to become a personal (previously called sponsored) member of CREST in his own right. In this case the investor remains the legal owner as well as the beneficial owner of his shares, while still benefiting from electronic settlement through the CREST system. And he retains the right to receive company information and vote on company affairs. Settlement and transfer arrangements are looked after by the client’s broker and, needless to say, there is a price to be paid for this service which may discourage many private investors from using it. However, at the end of January 2000 over 10,000 shareholders had taken up this option.
Finally, the investor may choose to stay outside the CREST system altogether, retain his share certificates and have his purchases or sales of shares registered each time with the company concerned, as in the past. Transactions will be more expensive and take longer than those going through the CREST system, but this may not be too much of a problem for existing private shareholders who deal only infrequently.
The emergence of large securities houses spanning a whole range of financial and stockmarket activities has its advantages: most types of financial service can be provided by a single organization. But it is not without its problems. Paradoxically, several of these disciplines ought to be kept well clear of each other. The investment management arm must not know if the corporate advice arm is counselling ABC Industries on a planned takeover of XYZ Holdings. If it knew, it could make large profits by buying the shares of XYZ before the bid became public. The marketmaking arm must not know if Myopic Mutual Assurance has approached the agency brokerage arm to acquire a couple of million pounds’ worth of shares in ABC, though the information would assist the marketmaker considerably in adjusting the price it quoted. The marketmaking arm must not learn of the intentions of the fund management arm, nor of ABC’s plan to take over XYZ. And so on.
To deal with the possible conflicts of interest and to convince the outside world that no improper use is being made of information available in different parts of the organization, safeguards are required. Securities houses have compliance departments or compliance officers with a brief to ensure the confidentiality rules are observed. Within the organization there are Chinese Walls: barriers that are supposed to exist between different arms of a securities house to prevent information from passing between them. Sometimes they are invisible walls. Sometimes the different arms are physically separated. Cynics claim they’ve never met a Chinese Wall that did not have a grapevine growing over it. Or, more succinct if less politically correct, that there’s no Chinese Wall without a chink.
Much of the old stock exchange terminology survives the structural changes in the London market. Somebody who sells shares he does not own in the hope that the price will fall and he will be able to buy them more cheaply before he has to deliver has undertaken a bear sale or a short sale. The investor is short of the shares – he does not own them – at the time he sells them. Short selling can be a dangerous game. If the price rises instead of falling, there is theoretically no limit to the price that might have to be paid for the shares that are required for delivery. Marketmakers have to sell shares they do not own in the course of their daily trading. The disappearance of the account system makes it more difficult for private individuals, though there are now opportunities for betting on a price fall with traded options or even via stockmarket index betting systems run by traditional ‘bookies’.
The term bear (see Chapter 7a) is used not only to cover a short seller but anyone who expects the market to go down. By extension, a bear market is a falling market and a bearish news item is one that might be expected to cause the market or an individual share to fall.
The opposite of a bear is a bull, who expects prices to rise. A bull market is a market on a long-term rising trend and bullish news is news that is likely to push prices up. Long is (self-evidently) the opposite of short. Somebody who is long of a particular share owns the share in question – possibly with the implication that he holds large quantities which he intends to sell rather than holding for the long term. A stale bull is somebody who bought shares in the hope of a price rise, has not seen the rise and is tired of holding on.
Though the newspapers normally quote only a middle price for a share, we have seen that the marketmaker quotes a price at which he will sell and a price at which he will buy. The marketmaker’s selling price is the offered price (the higher of the two, and the price at which the investor will buy). The marketmaker’s buying price is the bid price (the price at which an investor can sell to him). The difference between the two is the spread or turn. Different marketmakers may quote a different range, depending on the state of their books and whether they want to encourage investors to buy from them or sell to them. Thus you might see:
|
Marketmaker A |
Marketmaker B |
Offered |
102p |
103p |
Bid |
100p |
101p |
The spread is the same in both cases (though it need not be). The likelihood is that marketmaker A is long of the particular share. He wants to encourage investors to buy from him so that he can square his book, so he is prepared to sell to investors at 102p. Marketmaker B is probably short of the share, so he will only sell at the higher price of 103p to discourage still more investors from buying from him shares that he does not have. But he is prepared to offer investors 101p if they will sell to him, thus hoping he can pick up the shares he needs to square his book. An investor who wanted to buy would naturally get the best price from marketmaker A and one who wanted to sell from marketmaker B. The difference between the lowest offered price and the highest bid price (in this case 1p) is known as the touch.
The stock exchange publishes a Daily Official List of prices of all shares traded on the stock exchange or the Unlisted Securities Market. But since it gives the highest price and the lowest price at which dealings took place during the day, the spread is unrealistically wide. In an adjusted form, however, these official prices are relevant for some tax purposes, particularly probate. Of more interest is the information in the Official List on prices at which deals actually took place. Details of price, size and time of transactions allow the day’s performance to be tracked.
In the past many would-be small investors were deterred from direct buying and selling of shares by the ‘clubby’ nature of the stock exchange and the feeling that their business would not be welcomed. They may have been right, though the LSE has for a long time been prepared to provide a list of brokers who would accept private client business. Today the position is rather different. There are now a considerable number of brokers, including subsidiaries of major high-street banks, prepared to offer a ‘no frills’ share buying and selling service at relatively low cost. This is usually described as an execution only service, as it does not include the traditional investment advice and hand-holding. Some of these brokers use the Internet as a channel for orders, though a distinction needs to be made between those that simply accept instructions by, say, e-mail and those that allow investors to place buy and sell orders on-line: the true Internet brokers. Needless to say, any broker will want a certain amount of information from a potential client to enable him to establish the client’s bona fides and ability to pay. In turn, the client needs to satisfy himself in advance as to the precise service he is getting and the amount of commission he will pay. Though commission is usually expressed as a percentage of the value of the trade, there will probably be a minimum commission per transaction which can make very small deals relatively expensive. However, with many brokers these minimum commission levels are considerably lower than in the past.
Needless to say, the world’s major stockmarkets have their web sites on the Internet and generally provide useful background and news of up-to-the-minute developments in the market structure. The London Stock Exchange is at www.londonstockexchange.com. In addition to the traditional fare, the site now provides a section on the new techMARK market in technology stocks. The New York Stock Exchange is, unsurprisingly, at www.nyse.com/ and the US Nasdaq market at www.nasdaq.com/. Links to the sites of these and other world stockmarkets can be found at the Peter Temple Associates Linksite at www.cix.co.uk/~ptemple/. ProShare, the organization promoting share ownership in the UK, provides quite a bit of very basic investment guidance at www.proshare.org.uk/. The Ofex quasimarket has a site at www.ofex.co.uk/. More information on the UK’s CREST electronic settlement system can be found at www.crestco.co.uk/ and there is information on safeguards for stockmarket investors at the Securities and Futures Authority site at www.sfa.org.uk/. For results of an annual survey ranking UK investment analysts, go to www.primarkextelsurvey.com/results/.
Share prices both for UK and overseas companies are available at a wide range of sites. The usual position is that you have to pay for ‘live’ prices, but prices with a built-in delay of 15 or 20 minutes are available free (this should be quite adequate for most private investors). The Peter Temple Linksite provides pointers to a number of sources. It also provides a useful list of links to UK and US stockbrokers’ websites, with an indication of whether they provide web-based dealing services. For comprehensive details of UK stockbrokers and an indication of their services and charges, go to the Investors Chronicle site at www.investorschronicle.co.uk/ (be careful not to confuse this with an American newsletter site with a somewhat similar name!).