Friday, March 28, 2014

Capital Market Intermediaries

1.    Introduction

Various intermediaries plays important roles in a financial transactions those are happening every day. We will firstly discuss intermediaries with respect to equity only - because equity is considered to be the simplest asset class in capital market world. In a security's life cycle, in each phase from issuing an instrument in Primary Market to buying that instrument in Secondary Market. Though in Secondary Market, for a transaction (combination of buy and sell order) actual security movement occurs between two parties - buyer and seller, in background lot of intermediaries exist and facilitate a smooth movement.
Let us consider two persons Mr. Bagchi and Mr. Sharma who consider them to be good friend of each other and Mr. Bagchi sold his House to Mr. Sharma. So, there exist two possible movements
  1. House Movement: From Mr. Bagchi -> Mr. Sharma
  2. Money Movement: From Mr. Sharma -> Mr. Bagchi
The above mentioned movements are associated with a contract between Mr. Bagchi and Mr. Sharma. In Capital Markets terminology this can be termed as a Trade happened between Mr. Bagchi and Mr. Sharma. Therefore, in a generic way it can be said that, as part of the trade or contract, two parties entered into an agreement where both the parties agreed to pay corresponding security at a pre specified date. The pre-specified date in the agreement is usually termed as Value Date in the contract.

As a most desirable situation, on the Value Date, the Hose Movement and Money Movement will happen. But if due to some reason say Mr. Bagchi is not agreeing to handover the possession of his house to Mr. Sharma. So, it can be inferred from this case that guarantee plays more important role than trust. This incident necessitate a third party to enter into the situation which can play a role of guarantor. In this regard, one or more third party may exists in a simple to most complex financial transaction. In the Capital Market world, these third parties are usually termed as Intermediaries.
In the above case, including the guarantor there may be more intermediaries and those may be categorized as one of the followings:
  • Bank – Responsible for managing cash movements and maintenance.
  • Guarantor – Role is already mentioned in the above paragraphs
  • Agent or Broker – In a case where buying and selling parties are not known to each other instead they entered into an agreement through an agent or broker
  • Exchange – In case, there exists a central market where more than one broker is dealing among themselves to facilitate transactions of various properties etc.
Intermediaries do exist in every place whether it is a capital market or a wholesale market etc. It should be noted that one single entity can play role of one or more intermediaries simultaneously.

2.    Capital Market Intermediaries

The securities market essentially has three categories of participants, namely, the issuers of securities, investors in securities and the intermediaries. While the corporates and government raise resources from the securities market to meet their obligations, it is households that invest their savings in the securities market.

Capital Market Intermediaries are any entity those act as a middleman between two parties in a financial transaction.

Capital Market Intermediaries are also termed as Financial Institutions. Capital markets intermediaries are licensed and regulated under the regulation act of a country. Capital Market Intermediaries can be categorized based on their roles and responsibilities. Financial intermediaries offer a number of benefits to the average consumer including safety, liquidity and economies of scale. Following are some of the intermediaries in a capital market. IT should be noted that there may exist more entity in this regard.

  1. Broker-Dealer or Agent: Act as one or many roles of that of Trading Participant, Settlement Participant, Clearing Participant
  2. Bank: Provides safe-keeping services for cash
  3. Custodian and Depository: Provides safe-keeping services for all kinds of instruments - usually provides services in Dematerialized form
  4. Exchange: Provides a platform facilitate trading services - online, offline, over-the-telephone etc.
  5. Central Counter Party (CCP): Plays the role of counter party of both the parties in a transaction and thus eliminates the risk of non payment of cash or non delivery of security from any of the parties. Usually novate a trade into two trades. So, if there exists one CCP in the above mentioned example in Indtroduction section, original agreement will be broken into two agreement as one between Mr. Bagchi and CCP and the other between CCP and Mr. Sharma
  6. Clearing Participant: Takes the responsibility of transferring the cash and security to the relevant party.
  7. Registrar: Maintains a record of who is holding what. This usually provides service to the security issuer. Issuer, at the time of Corporate Action announcement and entitlement, refers to the relevant Registrar.
  8. Regulatory Body: Though act as one of the intermediaries, usually regulates and controls the operations of other intermediaries. This is usually a government body.
  9. Some more examples are Mutual Fund, Pension Fund etc.
Following table shows regulating authorities of some of the countries:

Sl. No.
Regulating Authority
  • Securities and Exchange Board of India (SEBI)
  • Ministry of Corporate Affairs (MCA)
  • Reserve Bank of India (RBI)
  • MAS (Monetary Authority of Singapore)
United States
  • Securities & Exchange Commission (SEC)
  • Commodity Futures Trading Commission (CFTC)
  • Federal Reserve System ("Fed")
  • Federal Deposit Insurance Corporation (FDIC)
  • Financial Industry Regulatory Authority (FINRA)
  • Office of the Comptroller of the Currency (OCC)  and etc.
  • Australian Prudential Regulation Authority (APRA)
  • Australian Securities and Investments Commission (ASIC)
Hong Kong
  • Hong Kong Monetary Authority (HKMA)
  • Hong Kong Securities and Futures Commission (SFC)

3.    Importance of an Intermediary

Question may be asked whether it is at all necessary to transact through an intermediary. 

Yes, It is advisable to conduct transactions through an intermediary. For example, you need to
transact through a trading member of a stock exchange if you intend to buy or sell any security on 
stock exchanges. You need to maintain an account with a depository if you intend to hold securities in
demat form. You need to deposit money with a banker to an issue if you are subscribing to public
issues. You get guidance if you are transacting through an intermediary. 

In case of India, chose a SEBI registered intermediary, as he is accountable for its activities. The list 
of registered intermediaries is available with exchanges, industry associations etc.

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