So how’s that long beta strategy working for you?

Stockbrokers enjoy a monopoly on share trading here, so why are they behaving like investors owe them a living during this downturn

By Shamindra Kulamannage.

Published on March 25, 2013 with No Comments

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During the market bubble easy money attracted investors to the business of running a stock brokerage. Some licensees adapted their brokerages to serve the volumes generated by retail investors who in their frenzy accounted for as much as 85% of market turnover. Many stockbrokers, who allowed clients to buy ridiculously priced shares were either ignorant, misunderstanding their role and obligations, or overcome with glee at how easy it was to make money, ignored the obvious issues.

After the bubble they perpetuated burst and pickings became thinner; many grumble about the number of stockbrokers serving a market with the turnover levels that Colombo’s listed stocks generate. Some even blame the suicidal pumping and dumping of shares as a necessary outcome of the regulator, the SEC, having awarded so many broker licenses leaving them no other avenue but to look the other way in the face of rampant market manipulation, to earn a living.

Clearly the regulator’s inability to ensure a level playing field for all market participants damaged the market’s credibility in the eyes of the very people whose savings stockbrokers were so keenly wooing. Worse still market manipulators escaped any sanction. This is all history. To contend that severe competition is somehow to blame for the blood bath is silly; it was wholly and entirely due to regulatory inaction in the face of rampant price manipulation, possibly the worst crisis the market has faced since the SECs creation.

Mar12013 markets2-01Grumbling brokers, who sometimes behave like investors owe them a comfortable living, are suggesting that brokerage be increased, their numbers be reduced and funds collected for market development through the CSE monopoly, be used to subsidize their investments.

Stockbrokers are having a difficult time no doubt, some are downsizing and a round of layoffs may be around the corner. A problem of overcapacity is not a new phenomenon, in the economy or even for the stock broking industry. Just over a decade ago, when daily market turnover levels often fell below a few million rupees, brokers went through a similar rationalization. Many downsized and others sustained losses for years. But it takes a remarkably weak grasp of market fundamentals to complain that competition howsoever is a bad thing.

After the bubble they perpetuated burst and pickings became thinner; many grumble about the number of stockbrokers serving a market with the turnover levels that Colombo’s listed stocks generate. Some even blame the suicidal pumping and dumping of shares as a necessary outcome of the regulator, the SEC, having awarded so many broker licenses leaving them no other avenue but to look the other way in the face of rampant market manipulation, to earn a living.

Clearly the regulator’s inability to ensure a level playing field for all market participants damaged the market’s credibility in the eyes of the very people whose savings stockbrokers were so keenly wooing. Worse still market manipulators escaped any sanction. This is all history. To contend that severe competition is somehow to blame for the blood bath is silly; it was wholly and entirely due to regulatory inaction in the face of rampant price manipulation, possibly the worst crisis the market has faced since the SECs creation.

Grumbling brokers, who sometimes behave like investors owe them a comfortable living, are suggesting that brokerage be increased, their numbers be reduced and funds collected for market development through the CSE monopoly, be used to subsidize their investments.

Stockbrokers are having a difficult time no doubt, some are downsizing and a round of layoffs may be around the corner. A problem of overcapacity is not a new phenomenon, in the economy or even for the stock broking industry. Just over a decade ago, when daily market turnover levels often fell below a few million rupees, brokers went through a similar rationalization. Many downsized and others sustained losses for years. But it takes a remarkably weak grasp of market fundamentals to complain that competition howsoever is a bad thing.
Mar12013 marketsBeing rather small, Sri Lanka’s stock market is governed by rules that limit the freedom of participants in the interest of efficient price discovery. These rules have bestowed, perhaps unintentionally, monopolies on stockbrokerages, the Colombo Stock Exchange and its electronic clearing system called CDS.

Brokers, despite the whining, have a monopoly on trading listed shares in Sri Lanka. Curiously there is no practical or legal avenue for a listed stock owner to bypass the market monopoly of the Colombo Stock Exchange to sell a share she or he owns or buy a share. CSE has the simple pleasant task of collecting the monopoly fees. Monopolies, even for the lauded aim of efficient price discovery, should generally be frowned upon. In many markets companies can have dual listings. But the more potent weapon is the Over the Counter (OTC) markets.

Because trading of a listed stock is not the monopoly of a stock exchange, investment banks which have brokerage license, trade most of the shares outside the market. Why should they pay fees to an exchange which hasn’t rendered a service when, for instance, the brokerage have sourced both a buyer and seller for a transaction. So called Multilateral Trading Facilities (MTFs) in Europe have grabbed huge market share off more expensive, slow and arrogant stock exchanges. There are more sophisticated versions of MTFs called Dark Pools run by investment banks which don’t disclose trading volumes & liquidity and transactions are anonymous. This is price discovery at its purest.

Clearly allowing a freer market here would bankrupt the CSE and floor the regulator who is struggling to prosecute an unsophisticated bunch of manipulators, despite having a world class surveillance system. If there is a lesson in this, it’s that markets are a far more powerful tool than they have been allowed to be.
Stockbrokers angling for limits on competition should understand that for efficient price discovery, it’s deregulation and not reregulation that’s going to work.

There is no easy solution for the overcapacity facing stockbrokers. There are however options, although none as easy as sitting around collecting fees for doing nothing much. Firstly, they have to figure if they are stockbrokers for the high street or brokers for institutional investors. Advent of internet trading has made it easier for investors to directly limit the roles of brokers to a degree. Many were geared for the bull market or were anticipating long term share price volatility – In investment jargon a long beta strategy. Clearly since this is no longer viable they may have to reposition their businesses. Discount brokering will face serious challenges from internet trading.

Secondly, the smarter brokers have already diversified their businesses to include some investment banking. Survival as a standalone stock brokerage will perhaps be unviable for much longer. Thirdly, serious brokers can look to attract foreign institutional investors thereby growing the pie instead of competing for a bigger piece of a smaller pie. Fourthly, they have to be up to stocking it out through lean economic times.

In many cases it is a combination of these and stamina that will keep the stockbroker licensees in business. Of all people stockbrokers should understand how markets work.

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