Broker: Definition, Types, Regulation – Guide for UK Investors

When investing in the stock market, there are a few items that you should be aware of. In this article, we will discuss the broker’s role, its types and what you need when choosing one.

magnifying glass over the word brokers

What is a Broker or Stockbroker?

A broker is a crucial financial intermediary, typically a company, that facilitates buying and selling orders in financial markets on behalf of clients. Brokers earn a fee for their services.

In financial markets, individuals or entities must use intermediaries to buy and sell assets, as securities exchanges only accept orders from individuals or firms that are members of that exchange. Brokers are, therefore, these intermediaries, which execute the orders on behalf of their clients. They are registered and licensed entities operating within regulatory frameworks to ensure market integrity and client protection.

Types of brokers

In addition to financial brokers, various other types of brokers exist, each serving different purposes. These brokers share the common thread of facilitating sales, but they specialise in specific areas:

  • Real estate broker: Buys and sells real estate properties.
  • Insurance broker: Sells insurance products to retail customers.
  • Energy broker: Buys energy from the wholesale markets and sells it to retail consumers.
  • Agricultural broker or farm broker: Buys and sells agricultural products.

However, we will discuss the type of brokers in the area of financial markets:

Discount Broker

A discount broker is a stockbroker who executes buy and sell orders at reduced commission rates compared to full-service brokers. Unlike full-service brokers, discount brokers do not provide investment advice or perform analysis for clients. With the advent of better communication technology and the Internet, discount brokers have become prevalent, enabling individuals with smaller capital to trade at lower fees through online platforms. Discount brokers are nearly synonymous with online brokerages, making them a significant segment of the fintech industry.

Key characteristics of discount brokers include:

  • Lower fees due to the absence of services such as personal consultations, advice, and research.
  • Primarily operate online, reducing overhead costs.
  • Offer services aimed at self-directed traders and investors.
  • Provide electronic trading platforms beneficial for active traders, including charting and position monitoring services.
  • Ideal for frequent traders and those with small portfolios who do not need extensive advice.

Full-Service Broker

A full-service broker is a licensed financial broker-dealer firm offering a wide array of services such as research and advice, retirement planning, tax tips, and more, at higher commission rates than discount brokers. These brokers are ideal for individuals who lack the time or expertise to handle complex financial planning and investment decisions on their own.

Key characteristics of full-service brokers include:

  • Wide range of financial services: Research and advice, portfolio analysis and construction, estate planning, tax advice, and access to IPO shares and foreign markets.
  • Higher fees: Commissions and fees are significantly higher than those of discount brokers due to the comprehensive services offered.
  • Personalized support: Clients can access individual stockbrokers and financial advisors, providing a one-stop shop for investment and financial management.
  • Proprietary products: Access to in-house mutual funds, portfolio management, insurance, loan services, and exchange-traded funds (ETFs).
  • Physical office locations: Clients can visit offices for face-to-face consultations.
  • Potential conflicts of interest: Brokers may have incentives to sell certain products that benefit their firm, leading to higher fees or “churning” securities in clients’ portfolios.

Discount Brokers Vs Full-Service Brokers: Main differences

FeatureDiscount BrokersFull-Service Brokers
Services ProvidedBasic order execution, minimal additional servicesComprehensive financial services including research, advice, retirement planning, and tax tips
FeesLow commissions, often no fees for certain tradesHigh commissions and fees for various services
Investment AdviceNone providedPersonalized investment advice and consultation
Target AudienceSelf-directed traders and investorsIndividuals seeking professional guidance
PlatformPrimarily online platformsBoth online platforms and physical office locations
Products OfferedStandard investment productsProprietary products including mutual funds, portfolio management, and insurance
Client InteractionMinimal, mostly digital communicationAssigned personal stockbrokers or financial advisors
Research and Analysis ToolsBasic tools for trade execution and monitoringAdvanced research, proprietary reports, and detailed analysis
Access to Special ProductsLimitedAccess to IPOs, senior notes, preferred stocks, and alternative investments
CostLow-cost, suitable for frequent traders and small portfoliosHigh-cost, suitable for high-net-worth individuals and those needing detailed planning
Potential Conflicts of InterestLess likelyMore likely due to incentives to sell certain products
TransparencyHigherRisk of reduced transparency and “churning”

Broker Regulation UK

Securities brokers register with the Financial Conduct Authory (FCA), the financial authority in charge of approving financial entities to provide services. This information is key to understand as if a broker is not registered within the FCA, it is not supposed to be serving UK residents. Before Brexit, it was allowed to be registered within one of the EU regulator such as the AFM in the Netherlands, BaFin in Germany or CNMV in Spain as it was allowed to service among the whole EU.

By being registered within the FCA, the broker is expected to follow specific guidelines to protect the investor interests and, due to this fact, allows to protect the investments via the Investors Protection Scheme such as the FSCS (Financial Services Compensation Scheme).

Differences between Broker, Trader and Dealer

Most people have heard the words Broker, Trader or Dealer and its a normal mistake to confuse them. We herevy explain the main differences.

Key differences between a Broker, Dealer and Trader:

AspectBrokerDealerTrader
RoleExecutes trades on behalf of clientsTrades on their own accountBuys and sells assets
Acting on Behalf ofThird partiesThemselvesThemselves or third parties
Market ParticipationIndirectDirectDirect (through brokers)
Primary IncomeFees and commissionsProfit from tradingProfit from trading
Regulatory RequirementMust be licensed and registeredMust be licensed and registeredNo licensing required, but must use brokers
Experience LevelVariesTypically highVaries
Service OfferingExecutes orders, may offer adviceProvides liquidity, can advise on complex transactionsExecutes trades, makes market decisions
Risk ExposureLow to moderateHighHigh

Differences between Broker and Trader

Brokers and traders are interdependent but distinct. Brokers execute trades on behalf of clients, while traders buy and sell assets for themselves or others, always through a broker. This distinction ensures that only authorised entities participate directly in financial markets.

Differences between Broker and Dealer

To clarify the role of a broker, it helps to compare them to dealers. While brokers act on behalf of clients, dealers trade for their own accounts. Some financial entities function as both, offering a blend of brokerage and dealer services. Dealers often have more market experience, providing advisory services for complex financial operations like IPOs (Initial Public Offerings) and capital increases.

How to become a broker?

Many people are drawn to the profession of a stock broker due to portrayals in movies like “The Wolf of Wall Street” and “The Big Short.” However, the reality of the profession can differ from these depictions. To become a stockbroker professionally, one must follow specific steps.

First and foremost, one should pursue academic training, primarily in fields related to economics, finance, or engineering, which are relevant to the responsibilities of a stock broker. Specialised master’s degrees or financial certifications like the Chartered Financial Analyst (CFA) certification can enhance one’s qualifications and prospects in the industry. While formal education is valuable, exceptions do exist, and individuals with exceptional skills and aptitudes may still find opportunities in the field.

FAQs

What is a broker and why do I need one?

A broker is a financial intermediary that facilitates the buying and selling of financial assets like stocks and bonds on behalf of clients. You need a broker because regulations require individuals to use licensed intermediaries to trade in financial markets.

What are online brokers, and why are they popular?

Online brokers are traditional brokers who provide a digital platform for executing trades. They are popular due to the convenience and accessibility they offer to investors, allowing trades to be made from anywhere with an internet connection.

What should I consider when choosing a broker?

When choosing a broker, consider your investment needs, the broker’s reputation, fee structures, and the level of service provided. Assess whether they offer comprehensive support or just basic trade execution.

What regulatory bodies oversee brokers in the UK?

In the UK, brokers are regulated by the Financial Conduct Authority (FCA). The FCA ensures that brokers adhere to strict standards of conduct, protecting investors and maintaining market integrity.

How does a broker differ from a dealer?

A broker executes trades on behalf of clients and earns fees or commissions. In contrast, a dealer trades for their own account, seeking to profit from buying and selling assets directly.

How do brokers make money, and will their fees eat into my profits?

Brokers earn through commissions or fees for executing trades. While fees can affect returns, a skilled broker’s advice can lead to better investment decisions, potentially outweighing the costs.

Can I trust my broker with my financial information and investments?

Brokers are regulated by financial authorities, ensuring they adhere to strict security and ethical standards. Choosing a reputable, licensed broker is key to safeguarding your financial information and investments.

What is the difference between a full-service broker and a discount broker?

Full-service brokers offer a wide range of services, including investment advice and research, charging higher fees. Discount brokers provide basic trade execution at lower costs but offer limited advisory services.

What types of accounts can I open with a broker?

Brokers typically offer various types of accounts, including Individual Savings Accounts (ISAs), Self-Invested Personal Pensions (SIPPs), and standard trading accounts. Each type of account offers different tax advantages and investment options.

Can I use multiple brokers for my investments?

Yes, many investors use multiple brokers to diversify their investments and take advantage of different services, fee structures, and investment opportunities each broker offers.

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