Despite the slowdown in the global economy due to Covid-19, the financial services market continues to hold its position.
According to estimates, the global financial services market can reach $26.5 trillion by 2022.
In most cases, while dealing in the financial markets you will need to go through an intermediary, which is called the brokerage.
But what is it? And what does it do exactly?
What is a broker?
The broker plays an essential role in securities exchange.
Because exchanges generally accept orders from their members only, the investors require the services of registered brokers.
Brokers are compensated for their assistance in different ways – commission, fees, or other means.
A broker acts as an intermediary who arranges a financial transaction between two parties for financial gains.
The broker can be an individual or a firm dealing with different assets such as stock, forex, and real estate.
All financial orders require a licensed broker, that means whether you buy stocks or trade currencies, a broker is a link between a financial market and you.
Classification of brokers by Financial Instruments
There are different brokerages for various financial instruments & asset types:
- Stock broker
A stockbroker is a professional or an institution who executes buying and selling of shares on behalf of clients.
Stockbrokers are usually registered with the stock exchange or work for a brokerage firm. Most of the stock trades are now conducted through online discount brokers.
In South Africa, stockbrokers re regulated by JSE & investors can trade or invest via a regulated stock broker if you are looking to trade stocks.
Forex or CFD broker In CFD trading, a trading instrument’s value is derived from an underlying asset, but retail traders don’t own any assets.
Similarly, forex trading involves buying or selling one currency against another for a profit.
CFD trading and forex trading share several similarities, such as trading platforms, pricing methods, and both are executed in the OTC market.
However, there is a subtle difference between a CFD broker and a forex broker.
A CFD broker may offer different types of contracts in stock indices, energy, commodities, including currencies.
On the other hand, a forex broker provides mainly currency trading.
A CFD & forex broker could be a market maker, ECN broker or a combination of both.
Online Forex & CFD trading in South Africa is regulated by Financial Sector Conduct Authority.
Traders can trade forex & CFDs legally via any South African forex broker that is authorized by FSCA for offering forex trading & derivative instruments.
Commodities broker
As the name suggests, a commodity broker deals in commodities.
A firm or an individual who trades in the commodity market is known as a commodity trader. Commodity brokers facilitate orders for traders & provide trading services such as futures and options.
- Derivatives broker
A derivative is a financial instrument whose value is determined from the value of underlying assets such as commodities, metals, currencies, bonds, stock indices, and other instruments.
The most common type of derivative instruments includes Forwards, Futures, Options, and Swaps. A derivative broker is a firm who facilitates derivative trading for clients.
- Interest rate or Bond Market broker
A bond broker is a financial professional that acts as a counterparty for both buyers and sellers in the fixed income market. As the bond market usually involves OTC transactions, the bond brokers tend to charge significant commissions or mark-ups than other capital market assets such as stocks.
General types of brokers
Financial markets brokers deal in a wide range of asset classes, from real estate and stock exchange to forex and insurance.
Some brokers execute the orders on behalf of clients, while others may offer only advisory services.
Depending on their model, the brokers can be classified as one of the following:
1. Full-Service broker:
In addition to general brokerage services, full-service brokers offer comprehensive investment planning to their clients.
Their fees are usually higher than a standard broker.
The fees vary depending upon the number of services you opt for, such as retirement planning, tax advice, and research.
2. Floor broker:
A floor broker is an exchange broker authorized to execute orders for clients on the exchange floor.
Floor brokers mostly represent financial institutions, investment funds, large brokerage firms, and wealthy individuals.
They tend to be most active on stock exchanges, futures, and options exchanges.
- Retail Discount Broker or Commission brokers:
A discount broker typically is concerned mainly with executing the order. In a strict sense, they generally don’t offer any advice, research, or investment planning to their clients.
Discount brokers charge a low commission for placing the orders.
Many of the online brokers for trading or investing in stocks, FTFs, forex are also discount brokers who offer comprehensive trading services, including research and advice.
- Online Broker:
The brokers who offer online platforms to offer financial market services are called online brokers.
An online broker is similar to a discount broker; however, some online brokers can also offer research and advisory to their clients.
They charge a flat fee or a percentage for each executed trade. Active traders often prefer online brokers & generally online brokers offer their platform for all devices.
5. Institutional brokers
An institutional broker manages the entire buying and selling of securities of large institutional clients.
Their clientele includes banks, insurance companies, hedge funds, mutual funds, and firms.
Institutional brokers tend to focus on market sentiment and fundamental economics and deal in bulk or block trading (buying/selling 10,000 shares at a time).
Their enormous size puts them at a significant advantage on stock exchanges to influence different securities’ trading sentiments and prices.
They offer a wide range of services, including advisory services, investment banking, and IPO offerings.
- Broker-dealers
These brokers specialise in buying and selling securities for clients but can also execute trading orders for their own benefit.
In most cases, broker-dealers work for a giant firm or a bank.
When they buy and sell securities for themselves, they are called dealers.
On the other hand, those who execute orders on behalf of their firm are termed brokers.
For instance, in US firms like Charles Schwab and Fidel Investments are an example of broker-dealer firms.
- Advisors
Some brokers, such as institutional brokers or broker-dealers, can also act as financial advisors.
As they tend to know everything about trading in securities and instruments, they can provide financial advisory to their clients.
However, there is a difference between a financial advisor and a financial broker.
Investment advisors are paid an annual fee or a fixed amount to manage their client’s portfolio.
In contrast, a typical broker is paid commission to execute the trading orders.
Both are prohibited from working against the client’s interests.
Direct Market Access Broker & ECN Brokers
An ECN or a direct market access broker are generally linked to the forex market & they provide their financial offering through electronic communication networks (ECNs).
ECN brokers are non-dealing brokers & they only match the orders of market participants, unlike market makers.
As ECN brokers collect price quotations from several market participants (banks, traders, etc.), they can offer a tighter spread than conventional market maker forex brokers.
They usually charge a fixed commission per transaction.
- Investment service provider or portfolio managers or money managers
Investment service providers can be firms or individuals offering investment services for stocks, fixed income, debt, cash, tax saving schemes, retirement planning, and structured products to both individuals & institutions.
The clients often work with a Portfolio Manager who manages investment accounts based on the specific investment needs.
You get the freedom and flexibility to tailor-make your investment accounts for financial goals.
A money manager is someone who manages the securities portfolio for their clients.
Professional money managers usually don’t charge a commission for their services; instead, they take a certain percentage of the clients’ total managed funds.
They are bound by a fiduciary obligation to put the client first in all financial decisions.
They are also known as “portfolio managers,” or simply investment managers.
- Sub-Brokers and IBs
A sub-broker does the same function as a traditional broker but acts as an intermediary between the primary broker and the client.
For instance, a stockbroker is an intermediary between the stock exchange and an investor.
On the other hand, a sub-broker is essentially a middle man between the stockbroker and the client.
The main job of a sub-broker is to bring clients to a brokerage firm.
So their main motto is not to serve clients’ interests but the interests of their brokerage house.
An introducing broker (IB) is a sort of an intermediary that refers the customers to actual broker.
An IB is a person or firm that generally has direct relationship with the customers.
IBs usually work for a more prominent brokerage firm, or futures commission merchant (FCM) called a clearing house, or a forex brokerage.
Instead of getting direct commission from clients, they receive payments from FCM brokers or market makers.
