9.3 Trading securities in the UK Flashcards
Give a short introduction to the LSE.
The LSE provides a marketplace where over 3,000 company securities, both domestic and international, are traded, including contracts for difference, covered warrants, debt, equity, depositary receipts, exchange-traded funds and real estate investment trusts.
What is the main purpose of an exchange?
To provide a centralised market place at which buyers and sellers can meet, and in doing so create the maximum possible liquidity and transparency for those products.
In addition to liquidity what else do exchanges provide?
All exchanges in the UK need to be recognised by the Financial Conduct Authority (FCA). In acquiring recognised status, an exchange has proved that it has adequate rule making and monitoring facilities to govern its members and their trading activities. In this way an exchange also provides orderly markets on which to trade.
Name the 7 trading systems, the kind of system they are and give examples of what is traded.
- SETS is a continuous order book execution system for the FTSE All Share index and liquid AIM and Irish shares.
- SETSqx is a hybrid system. It is used for periodic order book execution with market maker support for most other UK shares.
- SEAQ is a quote-driven system for any shares too illiquid for SETS or SETSqx, as well as corporate bonds.
- The International Order Book (IOB) is an order-driven system for international depositary receipts.
- The European Quoting Service (EQS) is a quote-driven system for European-listed securities.
- The Order book for Retail Bonds (ORB) is a retail-focused order book trading for gilts, supranational bonds and corporate bonds.
- The International Board facilitates reciprocal trading arrangements between LSE and other exchanges currently only the Singapore Stock Exchange has joined
Name the 3 other systems and their function.
- European Trade Reporting enables members to meet their post-trading obligations.
- LCH.Clearnet is a central counterparty to all trades executed on the SETS order book. It manages default risk on behalf of members.
- CREST is a settlement system for UK and Irish securities, it is owned by Euroclear UK and Ireland.
How can a firm trade on an investment exchange?
By being a member of the exchange.
Is there only basic membership to an exchange?
No! there are different forms of membership and a range of roles and obligations that can be taken on in addition to the basic membership.
What are the 2 ways a broker/dealer trade in?
A broker/dealer can trade in one (or both) of two ways:
- Buy and sell securities on behalf of clients (act as agent)
- Buy and sell securities for their own account (act as principal)
Define dealing (principal trades).
By acting as principal, the firm is taking a position itself, i.e. ‘running a book’. The aim is to make a turn on the trade (buy low, sell high). When acting as principal the trade will be assigned to the firm’s house account.
Define broking (agency trades).
Alternatively, the firm may act as agent on behalf of a client. In these circumstances, the firm will not take a position but instead earns commission on the trade. When acting as agent, the trade will usually be assigned to a segregated account which is separate from the firm’s own account. Some clients may, however, consent to their trades being allocated to a non-segregated account.
Define dual capacity.
Due to the fact that a member firm may act either as agent or principal to a trade, they are said to have dual capacity.
What are market makers?
Market makers are member firms that have volunteered to provide liquidity (make a market) in a security.
How do brokers/dealers become market makers?
A broker/dealer on the London Stock Exchange will apply to the LSE to register as a market maker. They will register to provide a market in a specific security.
How do market makers provide continuous liquidity in the markets?
By providing buy prices (bid) and sell prices (offer) to the market throughout a set time called the mandatory quote period (MQP). During this time the market maker is obliged to trade with clients at the prices quoted.
What does the market maker guarantee for the exchange?
The market maker is a guaranteed buyer and seller of the security in which they are registered.
What are fixed income market makers (FIMMs)?
Market makers registered to provide liquidity in the bond market.
What happens when the users of an inter-dealer broker (IDB) agree on a trade?
When the users of an inter-dealer broker (IDB) agree a trade, the inter-dealer broker (IDB) would act as central counterparty to the trade, in order to maintain its clients’ anonymity. This means that the IDB buys from Market Maker 1 and sells to Market Maker 2. The inter-dealer broker (IDB) is not making a spread on this trade as it earns its profit from fees and commission.
Describe the process depicted in the diagram.
After the market maker has sold the shares ‘short’ to an investor, it will borrow stock via an SBLI so that it can settle its position with the investor. The SBLI in this example borrows shares from the pension fund.
The pension fund loses the benefits attached to the securities, i.e. voting rights. All rights are now attributable to the investor. The investor will become the registered owner of the shares.
The pension fund loses out on any dividends paid on the shares during the time the stock is being lent out, an artificial dividend will be manufactured into its fee.
The pension fund is only lending the stock out, and will therefore want it returned at some point in the future. It is the responsibility of the market maker to return the equivalent shares to the pension fund at a pre-determined future date.
