Are stockbrokers conspiring against you?

2013-08-14 10:00

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A strong case can be made that they’ve become parasites, feeding on your cash

The fees charged by South Africa’s stockbrokers for the trading of shares are among the highest in the world. A drastic reduction of these fees would encourage desperately needed saving and investment in South Africa.

Increased competition among stockbrokers is not only needed, but entirely possible. The comparable cost of providing stockbroking services in the US and the UK has been substantially reduced thanks to the advent of internet technology.

A core element of a free market is one in which economist Joseph Schumpeter’s process of “creative destruction” is allowed to occur, for example computers rendering the typewriter industry obsolete.

The process of creative destruction is not being allowed to occur to the JSE’s stockbrokers though.

To trade shares on the JSE, you need to go through one of the country’s several dozen stockbrokers, who are fee-paying members of the exchange.

The exchange charges its stockbrokers a minimum fee of R6.73 for trades of less than R82 000 and a maximum of R31.08 for trades of more than R380 000, more or less.

The stockbrokers in turn charge their clients, directly through your own trading or indirectly via your unit trusts, insurance policies or pension fund, far higher minimums and percentage-based fees that have no maximum.

One of the lowest costs stockbrokers charge is 0.4% of the traded value, subject to a minimum fee of R120.

For example, suppose one buys or sells shares worth R1 000, the cost to the investor would total R120 while the stockbroker would have paid the exchange’s fee of R6.73, netting a gross profit of R113.27.

For trades that have a total value of R50 000, R200 000 or R500 000, the gross profit to the stockbroker is roughly R193, R784 or R1 969, respectively.

The stockbroker’s profit increases as the amount traded increases, while the stockbroker’s costs are capped.

The high cost of online share trading restricts access and alienates South Africans from the capital markets and perhaps the notion of free markets itself.

It is seen as a preserve of the elites when the exchange ought to be the beacon of South Africa’s free enterprise capitalist system.

This kind of pricing was once justified in the pre-internet era. Back then, the stockbroker’s costs increased proportionately with the value of the order. The stockbroker may have had to employ more people or have taken more time to process it. This is no longer the case.

In sharp contrast to the rapacious pricing regime endured by South African investors, the brokerage fee paid for an online trade in the US, for an unlimited amount of shares, is fixed and ranges from $3.95 (R38.50) to $9.99 per trade.

For UK investors, the amount charged per trade ranges from £5.95 (R90) to £15.

The prices charged by the US and UK stockbrokers reflect a competitive market and there is no reason why similar pricing cannot be achieved in South Africa.

The exchange has imported the same computer system as used by the London Stock Exchange. It now needs to import the competition that exists among UK stockbrokers as well.

Local stockbrokers’ adherence to a pricing convention that is uncompetitive and prejudicial to their clients is not without precedent.

A mid-1990s case that involved collusion among the Nasdaq stock exchange’s market makers resulted in a record $1 billion settlement.

The market makers were stockbrokers who bought and sold shares for their own account. They earned the difference between the buy (or bid) and sell (offer) prices (which is called the spread). The market makers conspired by adopting a pricing convention that was to their benefit but to the detriment of their clients.

Prior to the Nasdaq adopting decimalisation, stock prices were quoted using fractions of eights, like IBM shares were quoted as: bid $58 1/8 and ask $58 5/8. Scrutiny of the market makers began after the publication of two articles in 1993 – one in Forbes magazine and another by academic economists in the Journal of Finance.

These articles noted the absence of share price quotes that included odd eighths (1/8, 3/8, 5/8 and 7/8).

It seemed innocuous, but it ensured that the market makers earned a minimum spread of $2/8 or $0.25 per trade rather than a logical minimum of $0.125. The authors of the Journal of Finance paper concluded that the omission of odd-eighth fractions in the quotes was because of tacit collusion.

The market makers and the Nasdaq vigorously denied the claims, even enlisting Nobel Prize-winning economists to their cause. A legal battle that pitted private litigants, the competition and the market regulator against the Nasdaq’s market makers ensued.

It was eventually established that the market makers did in fact collude.

When fees are higher than necessary and defy logic, they serve as a signal that the free market has failed.

South African stockbrokers have a choice too: exclusively offer an uncapped-percentage-on-volume pricing scheme that belongs to the pre-internet era – or offer flat rate pricing that reflects the real costs.

As in the Nasdaq case, a reasonable inference would be that South African stockbrokers, and possibly the exchange, are tacitly colluding by maintaining a lucrative anticompetitive pricing convention.

The exchange needs to act urgently to inject competition among stockbrokers. They could create another category of stockbroking, one that offers a stand-alone internet execution service with fixed rates or capped pricing.

Another solution would be to eliminate stockbrokers altogether. They are a redundant and costly layer. Trading can be offered via the exchange’s own website. Reducing trading costs would do more than any other initiative by the exchange to increase black ownership of listed companies and it should be a priority.

There is a case for government intervention. The minister of finance is duty bound by the Financial Markets Act, which regulates the exchange and its stockbrokers, to ensure that competition in the financial market is not being “impeded or distorted”. High stockbroking fees do just that.

» Singh is an independent consultant who has a master’s degree in statistics and actuarial science from Wits University

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