What is Brokered Market
A broker could be an individual or a firm that acts as an intermediary between two parties to carry out a deal. The broker charges a commission for his work which is known as brokerage.
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Types of market
- Dealers (OTC market)
Dealers Market is where the buyer or the seller of any security may approach the dealer for his transaction. The dealer act as a counterparty in the transaction. The dealer quotes 2-way for the transaction, i.e. they provide BID and ASK rates for the transaction. The BID rate is the rate at which the dealer is willing to purchase the defined security and the ASK rate is the rate at which the dealer is willing to sell the security. the difference between the two rates is called a spread. The spread is the profit for the dealer. Dealer market is common mostly in Forex and currency markets. Dealer markets are common for over-the-counter (OTC) products such as derivative products example forwards, futures, and options. This is because these products are mostly tailor-made as per individual requirements.
Exchange market is a structured market where in the buyer and the seller can transact in a defined market. The exchange market is automated i.e. if the buyer-sellers price gets matched and transact takes place. The exchange market is standardized in terms of quantity, quality, delivery terms, etc. Delivery terms and quality are not common in stock exchanges and bond exchanges. They are more appropriately used in commodity exchanges, and with derivatives involving assets that have these characteristics. For instance, gold and diamonds have qualities and ratings. In addition, the physical asset must be in a form that can be delivered to the buyer or contract holder. Such features are defined by the exchange. The benefit of the exchange is the provision of a central location to find their own counterparties for buyers and sellers. Exchanges are automated, involving no intervention from a broker or dealer.
In general terms, a broker is someone who, on behalf of others, buys and sells items. They are intermediaries between the two parties. The broker market functions by seeking a counterparty for buyers and sellers respectively. Brokers make money by charging their customers a fee or commission on each order they perform. Brokers know their market best, not only have experience in processed trading, but also in market behavior. Broker markets are used for all manner of securities, especially those with initial issues.
The broker cannot take their own position in the market, unlike the dealer who can take position long or short position in the market depending upon his view in the market. Let us look at the example of the forex dealer and forex broker.
A bank dealer quotes a BID rate for his export base customer $ 5 million at 76.00. In this transaction, he has bought $5 million at 76.00. the bank dealer can immediately sell the dollars which he had purchased from his customer in the market at the same rate or if he has a view that the rate will be going up he may opt to hold the long position and sell it when the rate of the dollar increases. Thus, to earn profit by selling above the price at which he has bought from his customer.
In the case of a broker the situation is not the same, if any entity approaches him to sell the dollar he has to find a suitable counterparty for the same and he has to transact at the market rate. Thus, the broker doesn’t earn in the price difference. He earns brokerage by bringing two parties.
The above example shows the dealer also has to face exchange rate risk at times when he doesn’t cover the transaction at the same time as the market is volatile and can go against the direction of the dealer. Brokers do not take their own position in the market, they just bring two parties together to transact.
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History of Brokered Market
Earlier there used to be no hotlines the forex broker use to run from one bank’s treasury to another bank’s treasury to take the order and match them up. They had to be really quick to compete with their rivals. This was the time when there was no system through which the banks could quote each other rate, they totally had to be depended on the brokers for price and find a suitable counterparty. Back in the day stock trading was not as efficient and sophisticated as it’s now and before the National Stock Exchange came into the picture there used to be a concept of ring trading wherein most big brokers would send their assistants to buy and sell shares based on prices negotiated with the use of hand signals. These trades would then be jotted down in Sauda-pads, color-coded pink or blue to indicate the status of each broker. Now at the end of the day, all the Sauda-pads were accumulated from all the brokers and a final bhav copy was produced from the details of these pads.
Modern Day Brokered Market
Most of the issues saw a massive outcry from the brokers who saw this as manipulation of the market. As a result, there was a gradual shift from the ring trading system to a more sophisticated screen trading system/platform. These technological advancements led to high volumes of trades being executed every day on the platforms as it was more transparent, fast, and cost-saving. On the other hand, the volume with the broker started to decline. A large share of the brokerage firms has moved to an online format. Smaller brokers have taken control of most individual investor’s accounts, along carrying out their trade they have also started providing services such as research analysis, wealth management, cross-selling, etc. The forex brokers also have faced a decline in their volumes as there are banks mostly use electronic platforms such as CCIL for their spot trades. Huge participation by banks of this platform has increased liquidity. Forward market however isn’t yet as liquid as the spot market. So many banks prefer a broker to find a suitable counterparty.
The added convenience and personal attention paid to the small investor has resulted in a large influx of activity. In addition, the fact that the online resources offer up-to-the-minute pricing and immediate trades makes their format appealing to the modern user. Discounted commissions have lessened the price of trades, giving access to a wider swath of people and adding liquidity to the market. The role of the brokers is ever-changing and proves to be a boon for the future of the financial industry. We cannot deny the fact that the Brokered Market plays a very vital role in the financial system.
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Author: Akshay Patil
About the Author: When I write I learn something new which acts as a value addition towards my career in finance.