Structural change
2.31 If growth in the availability and timeliness of information will
benefit many investors, changes in the roles performed by intermediaries
may lead to significant structural change in securities markets. Established
groups of participants in such markets, and their activities, underpin
the existing regime of corporate regulation. [28]
However, developments in electronic commerce threaten to blur and even
eliminate many of the traditional distinctions between the roles and related
activities of these participants.
2.32 One commentator has observed that the effect of the new technology
will be to eliminate intermediaries who add little value. Those seeking
to stay in business would need to rearrange their operations to ensure
that they did add value. [29]
2.33 Another commentator has pointed out that the extent to which particular
classes of intermediaries might be vulnerable depends on the specific
nature of the services they provide.
One service intermediaries sell is their superior access to information
about products and prices. Here they are vulnerable to competition from
what you could call the 'smart' Internet. Another service they sell
is the simple execution of transactions. Here, too, they are vulnerable.
A further service is advice on the product or investment that best suits
your particular needs. Such advice is capable of being provided by an
on-line interactive computer program, though many retail customers may
well prefer to have such advice provided by flesh-and-blood.
But yet another service provided by various classes of intermediary
is the shifting of risk from the shoulders of the client. The obvious
example is a deposit-taking intermediary. When I lend my money direct
to a borrower, I bear the risk of his default. But when he and I deal
... via an intermediary, the intermediary bears that risk. What's more,
I can lend at call, whereas the borrower borrows long-term. Somehow,
I don't think we should expect much financial disintermediation.
What we should expect is that those classes of intermediaries
most at risk of losing business through the rise of electronic commerce
will take evasive action. They will 'unbundle' the various services
they presently provide as a package, so as to save what can be saved
and to price more keenly those services most at risk. [30]
Implications for stockbrokers and stock exchanges
2.34 The changes implied in the above discussion can be analysed by looking
at the activities of specific market participants. For example, stockbrokers
provide securities advice to their clients, and undertake trades in securities
on their clients' behalf. They may also trade in securities as principals,
may be involved in the management of investment funds, and may be involved
in underwriting the issue of new securities. Each of these activities
may be affected by technological change.
2.35 Increasing competition in, and the proliferation of, securities
advice from all sources on the Internet is considered in paras 2.17 -
2.29 above. With regard to share-trading on the Internet, evidence suggests
that this can be conducted directly, at a greatly reduced cost. In 1996,
Business Week magazine introduced Mr Ed Harrison, a client of
Lombard Institutional Brokerage Inc - a discount brokerage that began
offering Internet trading in September 1995:
Harrison likes Lombard's low trading fees: His previous broker
charged as much as $160 a trade, vs Lombard's $36.50. But what he really
likes is to execute his own trades anytime he wants by computer and
to gain access, via the Internet, to lots of free and low-cost investment
information. Lombard even offers him a free quote service that allows
him to track a portfolio of 50 stocks. "My broker was so nice,
but boy, they were robbing me," says Harrison. "All he ever
did was place my trades. I can do that for myself." [31]
2.36 Another firm, E*Trade Group, claims to process more than 6000 Internet-based
share trades a day, at a transaction cost of less than $20 (as against
$80 for a typical trade through a discount broker):
The service E*Trade pioneered is undeniably appealing. E*Trade's
is, they say, a secure online marketplace. It is user-friendly; you
can type in the name of a company, for instance, and receive breaking
news. To set up an account, you mail in vital stats about yourself and
a check for $1000 to cover the minimum balance. The firm assigns you
a password, and you're ready to roll. [32]
2.37 E*Trade apparently opens 500 new accounts, and brings in between
$8 million and $10 million in new assets, each day. More generally, it
has been estimated that the number of online brokerage accounts in America
will grow from a current 1.5 million to 10 million in five years. [33]
On 7 May, E*Trade announced that it proposed to open its trading service
to Australian investors. [34]
2.38 Not all brokers accept that the new technology will directly affect
their activities. Many major US brokerage houses doubt the threat posed
by Internet share trading. Noting that they had retained most of their
clients in the face of competition from discount brokers during the 1980s,
and that most Internet firms lacked the financial strength and credibility
of the major firms, these firms concluded that the Internet simply could
not replace "a flesh-and-blood broker's counsel". As Business
Week observed, at present full-service firms appear to have little to
worry about - very few investors trade electronically, either on the Internet,
or through proprietary online services. [35]
2.39 However, in the near future, it seems reasonable to surmise that
simply facilitating trading on behalf of clients is likely to become more
competitive, less profitable, and perhaps, ultimately, redundant. This
prediction was echoed by the Chief Executive of the ASX, Mr Richard Humphry:
"Revenue for broking firms has traditionally been fees for
trading. I think there's going to be pressure on them to move away from
that to fees for information."
[Mr Humphry] said share trading on the Internet was still widely
regarded as unsafe because of the difficulty of securing privacy of
portfolio details. But once the security hurdle is overcome, online
trading can be expected to grow quickly. [36]
2.40 There is some evidence from America that supports this predicted
migration to the provision of market information. For example, Business
Week cited the case of Quote.com - an Internet news and advice organisation
- which successfully charged subscription fees of between US$10 and US$42
to active investors wanting instant access to financial analysis and news
and research, even though some of this information was also provided free
on a time-delayed basis. [37] Active
investors grew to depend on the service, and the prosperous subscriber-base
enticed profitable advertising to the site.
2.41 While collecting fees for providing specialist investment information
seems one likely response to technological change, such an approach will
have to contend with an Internet culture that remains conditioned by the
expectation that information is free. Broker-provided information will
also have to compete with the many other sources of information that exist
on the Internet.
2.42 Another response from brokers may be to emphasise their service
role as client advisers. Some broker-sponsored Internet sites are actually
the private sites of individual adviser's engaged by the firm. [38]
Permitting advisers to set up private sites under a firm name or the firm's
'umbrella' may enable those advisers to better service, and so retain
and attract, clients.
2.43 If the ultimate effect of electronic and Internet-based share-trading
by brokers on behalf of retail investors remains somewhat speculative,
there is likely to be a profound effect on trading by or on behalf of
institutional investors, and on securities exchanges generally. As the
Chief Executive of the ASX has observed, "people trading on the Net
won't be forced to go through a trading exchange". [39]
2.44 Both the ASX and the Sydney Futures Exchange (SFE) are seeking in
various ways to anticipate the implications of new technology. The SFE
has apparently been considering the merits of establishing a new electronic
share trading system known as LOCAM (or Large Order Call Market) for some
time. The system would enable institutions to place their trades anonymously,
masking both their identity and the size of the share block to be traded:
This is said to have several advantages over the ASX's trading
system, because the market would not know if an institution was seeking
to sell or buy, and so the price would not react accordingly. [40]
2.45 Institutions have repeatedly sought direct access to the ASX's SEATS
trading system. Responding to these demands, the ASX recently referred
to a proposed trial of a market to match up institutional orders after
the close of normal trading:
The new market maintains the same rules for order disclosure
as the main market, but the possibility of introducing an anonymous
matching market is also being examined, to better meet the requirements
of institutional investors in particular. [41]
2.46 Trading systems potentially in competition with "member-run
markets" such as the ASX already exist. Participants at an ASC electronic
commerce workshop instanced emerging principal-to-principal systems (embracing
both primary and secondary trading in a full range of financial products),
and broker-sponsored systems (where an electronic order matching system
owned by an individual broker in effect became a full trading platform).
An Australian example of a principal-to principal trading system was AUSMAQ.
In its fully developed form, AUSMAQ is intended to be a comprehensive
electronic trading mechanism for prescribed interest offerings. AUSMAQ
will enable trading to take place directly between principals using
screen trading systems. Trades will be matched in accordance with price-time
algorithms. As is required in new game mechanisms, AUSMAQ will check
before the execution of trades that cleared funds are available in buyers'
accounts, which are part of the system, and that cleared securities
are available in sellers' registries, which are also part of the system.
[42]
2.47 An Australian example of a "broker-sponsored" system is
POSIT - an order-matching system used by the stockbrokers Burdett Buckeridge
and Young. POSIT is used for trades in excess of $1 million and operates
outside normal SEATS trading hours. Workshop participants noted that its
development as a full trading platform depended on user acceptance and
regulatory approval. The system was said to have particular appeal to
institutional investors in providing an anonymous way for the conduct
of major trades. [43] The Reuters Instanet
system apparently operates in a similar manner, again outside the ASX.
[44]
2.48 Potential competition to established exchanges may also be provided
by company-conducted 'passive' listing services. Some American examples
of such services are noted in para 1.6 of this Paper.
2.49 It is worth noting that the Corporations Law currently prohibits
the establishment of an unauthorised stock market, and provides for Ministerial
approval of a stock exchange where that exchange satisfies a detailed
series of requirements. [45] In this
area, the Wallis Committee recommended that:
- the regulatory framework for all financial exchanges should provide
for initial approval and ongoing oversight by the proposed CFSC, which
should seek to ensure that any exchange operates a fair and efficient
market;
- the CFSC (rather than the Treasurer) should have the power to impose
conditions on securities markets and disallow amendments to exchange
business and listing rules; and
- the CFSC should have power to authorise a financial market dealer
to operate an over-the-counter market, subject to any conditions necessary
to ensure that the market is conducted fairly and that operational risks
are contained - there should be no separate authorisation of exempt
markets. [46]
2.50 It seems inevitable that there will be greater competition within
Australia between systems for trading securities. In addition to the developing
mechanisms noted in paras 2.44 and 2.47 above, on 15 April, Austock Brokers
received government approval to operate a computer-based, exempt stock
market outside ASX regulation:
While there have been some suggestions that the ASX might be
jealous of a newcomer, Austock is hoping that its initiative may, in
fact, produce a type of "nursery" for the main public market
in shares. [47]
2.51 There will be also be greater competition between markets and trading
systems internationally. The ASX has regularly referred to the need for
brokers, and for the exchange itself, to remain internationally competitive
or risk losing clients overseas. One commentator contends that, as investors
become more international in their outlook, so might the companies in
which they invest. Companies may choose to make their primary listing
on an exchange that offers them the most favourable regulatory regime
or the cheapest listing fees, knowing that investors in their home country
can access them electronically on that exchange. Such a move would simply
represent an extension of the existing trend to competition among stock
exchanges to attract companies from other countries to list. [48]
2.52 As a result, exchanges might themselves become specialists, as have
some brokers and advisers. For example, just as NASDAQ had become a world
centre for trading technology stocks, so the ASX might eventually become
a world centre for trading resource stocks. [49]
2.53 While the ramifications of change remain speculative, the fact of
change and the need to plan for change remain undeniable. To quote the
Chief Executive of the ASX:
There is no obvious reason why an Internet stock market would
need to involve intermediaries. Indeed, if such a market were to start
today, the reputed adventurous and individualistic nature of the typical
Internet user would probably ensure a principal-to-principal market,
with both funds and dematerialised securities lodged by participants
in advance of trading to provide instant settlement and largely eliminate
counterparty risk. The same is potentially true of new local markets.
An alternative view is that the Internet will have become a mass
medium by the time a significant stock-market appears on it, and that
the typical user will then be identical to today's private investor,
who finds a security benefit in dealing through an intermediary. The
question is open, and probably depends largely on timing.
2.54 In summary, the move to an international electronic market provides
brokers and exchanges with obvious opportunities and challenges. Australian
brokers and the ASX should gain access to an international (rather than
a national or regional) pool of issuers, investors or clients. [50]
However, some of the activities currently performed by these organisations
will become more competitive, less profitable and may ultimately be performed
by traders directly.
2.55 While some brokers will continue to offer the range of services
currently provided, others may evolve into information specialists, or
more specialised client advisers, or market-makers - increasingly trading
in securities as principals. This may have implications for the degree
of risk in securities markets.
2.56 Other brokers may offer order-matching services in competition with
existing exchanges. These will not necessarily seek to duplicate what
is offered by those exchanges, but may target particular groups of investors,
or trades of a particular size. The minimum standards to be met by such
new 'markets', and whether they should differ from the standards imposed
on the ASX, represent a challenge for regulators.
2.57 Exchanges themselves will face more vigorous international competition
for the listing of companies including, perhaps, competition from totally
electronic exchanges situated in 'cyberspace'. In this regard it is worth
referring in passing to Wit Capital Corp - an American investment bank
"that also aspires to become an electronic stockmarket on which the
shares of Internet offerings will be traded". Exchanges may respond
to this increasing competition in a number of ways, including by seeking
to specialise in certain types of stocks.
2.58 The Corporations Law currently licenses and regulates participants
in the securities industry, requires that securities exchanges be approved,
and explicitly recognises the enforceability of their listing and business
rules. While it regulates investment advisers, it deals only tangentially
with information providers, and does not specifically address situations
such as the provision of computer software that may assist investors to
capture and interpret information. [51]
Any blurring of existing distinctions, or changes to existing activities,
may require amendments to the Law, and some reconsideration of the limitations
of the existing enforcement regime.
Implications for corporate advisers and merchant bankers
2.59 Trends towards electronic capital raising are likely to affect other
participants in securities markets, including corporate advisory and merchant
banking firms. Among other activities, these firms advise companies seeking
to raise funds through the issue of securities, or arrange funds for such
companies. They may also advise shareholders seeking to acquire or dispose
of securities, and provide experts' reports in connection with takeovers,
mergers and privatisations. Technology is likely to affect the profitability
of some of these activities, particularly those involving the funding
requirements of small and fast-growing companies. For example, with reference
to capital raising in America it has been claimed that:
The few underwriters or venture capitalists who raise money for
small firms ... are astonishingly rapacious. A $5m offering might see
as much as $700,000 eaten up in costs. The Internet offers an alternative.
For $1200 Mr Dallavecchia has bought a computer program called CapScape,
which automates the tedious process of compiling an offer document.
By using the program and then offering shares directly to investors
over the Internet, Poof Products expects to raise its money at a cost
of less than $100,000.
The savings offered by CapScape are formidable. The American
government reckons that, on average, a share prospectus takes 900 hours
to complete. CapScape's interactive worksheets shrink that to just 11
hours or so. The completed form must then be shown to a lawyer for review.
But the professional fees involved in such an offering are relatively
tiny: a few thousand dollars against perhaps $200,000 for a conventional
prospectus for an initial public offering ... Those who now specialise
in raising money for small companies, particularly banks and venture
capitalists, will face unaccustomed competition. [52]
2.60 Interestingly, the developers of CapScape are simultaneously attempting
to develop a computer program to alert investors to the potential problems
in any such offerings. [53]
2.61 Clearly, the extent of structural change that might occur with the
adoption of new technology also remains speculative. However, some immediate
issues are obvious.
Some issues:
- how should the Law accommodate changes in the roles and activities
of participants in securities markets brought about electronic commerce?;
- how should the Law accommodate the establishment of new electronic
securities trading systems?;
- how should the Law accommodate principal-to-principal trading in securities?;
- how should the Law accommodate real-time settlement systems?;
- what regulatory approach should the Law take where Australian investors
wish to trade electronically from Australia on stock exchanges based
offshore?;
- in a global electronic marketplace, what is the continuing relevance
of:
a) existing ASX trading hours;
b) provisions in the Law dealing with marketable parcels and odd
lots of shares;
c) provisions in the Law dealing with the short-selling of securities;
d) provisions in the Law dealing with market manipulation; and
e) provisions in the Law enabling the ASC:
i) to prohibit trading in particular securities on a stock market
"whether in this jurisdiction or elsewhere" (s 775(1A));
and
ii) to have full and free access to the "trading floor"
of a securities exchange (s 776(3))?
Footnotes:
[28] Australian Securities Commission, Electronic
Commerce Project Issues paper, (August 1995) p 3.
[29] 'Essential to embrace the future', Business
Review Weekly, 24 February 1997, p 8.
[30] Ross Gittins, 'Will Electronic Commerce
Drive Structural Change in the Financial Services Industry and Enhance
Competitiveness of the Australian Capital Markets?' a Paper delivered
at Regulating the Marketspace, ASC Electronic Commerce Conference,
Sydney, 4-5 February 1997, p 7.
[31] 'With the World Wide Web, Who Needs Wall
Street?' Business Week, 29 April 1996, p 48.
[32] 'E*Trade: Is This Investing's Future?'
Fortune, 3 March 1997, p 125.
[33] 'E*Trade: Is This Investing's Future?'
Fortune, 3 March 1997, p 124.
[34] 'Net broker to establish Australian operations',
Australian Financial Review, 7 May 1997, p 23.
[35] 'With the World Wide Web' , Who needs
Wall Street?' Business Week 29 April 1996, p 49.
[36] 'Brokers face up to the virtues of virtual
trading', Sydney Morning Herald 11 January 1997, p 74.
[37] Martin Roth, The Internet for Investors,
Wrightbooks, Melbourne (1996) p 10.
[38] Martin Roth, The Internet for Investors,
Wrightbooks, Melbourne (1996) pp 11-12.
[39] 'Brokers face up to the virtues of virtual
trading', Sydney Morning Herald, 11 January 1997, p 74.
[40] 'SFE plans to pinch ASX's most lucrative
trades', Australian Financial Review, 21 February 1997, p 10.
[41] 'ASX fights for its share', Australian
Financial Review 26 February 1997, p 22.
[42] Australian Securities Commission, Electronic
Commerce Project Issues Paper (August 1995) pp 7-8.
[43] See, generally, Australian Securities
Commission, ASC Electronic Commerce Project Issues Paper (August
1995) pp 7-8, and Richard Salmons, 'ASX fights for its share' Australian
Financial Review, 26 February 1997, p 22;
[44] 'ASX needs to guard flanks and create
own niche', Australian Financial Review, 11 April 1997, p 65.
[45] Corporations Law ss 767 and 769.
[46] Wallis Committee Report, pp 283-4.
[47] 'New market outside ASX may provide share
nursery', Australian Financial Review, 15 April 1997, p 23.
[48] Martin Roth, The Internet for Investors,
Wrightbooks, Melbourne (1996) p 13.
[49] 'The ASX is talking Net worth', Australian
Financial Review, 21 March 1997, p 77.
[50] See, for example, the case of Pont Securities
as cited in 'Brokers face up to the virtues of virtual trading', Sydney
Morning Herald, 11 January 1997, p 74.
[51] See, generally, 'Smart agents on the Web
to track down specialist data', Australian Financial Review, 4
April 1997, p 23.
[52] 'On-line capitalism', The Economist,
23 November 1996 p 102.
[53] 'Raising capital in cyberspace', Australian
Financial Review Weekend Review, 7 February 1997, p 4.
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