Brokers skewered by market gyrations

The brokers, Joe Pagliaro and Wren Bligh, who between them wrote a substantial amount of Wilson's private client business, are on gardening leave. Their sudden departure sparked speculation as to how it had come to this, particularly given last month's warning that Wilson HTM faced an annual loss of up to $8 million, partly due to falling stockmarket volumes.

Speculation aside, their departure is a symbol of the growing turmoil that is enveloping stockbroking. People are either leaving or being made redundant. Some brokers are abandoning their market participant status with the ASX in favour of the relatively cheaper, and less regulated, shadow broking world, and the concentration of risk in third-party clearing continues to intensify.

In the past few years, more than 20 brokers have either collapsed, nearly collapsed or merged. Most have culled staff or instigated hiring freezes. Most brokers remain unlisted, but the few that decided to list on the ASX have found the experience excruciating.

Austock Asset Management's shares are trading at 12?, which is a far cry from the heights of $2.10 in December 2007. It is the subject of a recent takeover bid by Mariner Corp. Wilson HTM is trading at 19.5? a share, after trading at more than $4 in June 2007, and is trying to sell part of its Pinnacle Investment Management business. Meanwhile, Bell Financial Group is trading at 45?, after trading at more than $1.50 in 2007.

With trading volumes at low levels not seen in seven years, some market participants are hanging on by a thread. As one veteran said: "Every time they put the lights on they lose money."

There are three parts to a traditional retail business: retail advisory, institutional brokerage and corporate finance. In today's climate, retail advisory has fallen severely institutional has been butchered and, with few floats and even fewer equity raisings, corporate finance is on life-support.

Like retail, the media and manufacturing, stockbroking is going through structural changes. Many brokers complain that the phones hardly ring, particularly as self-managed superannuation funds have been putting more and more of their money into cash and bonds, and out of equities.

There is no doubt that the mindset is changing. The equities cycle has changed since the global financial crisis and the sovereign debt crisis. To further complicate matters, more investors are going for the cheaper online option to do their trading, which doesn't provide advice. Other bigger investors are increasingly moving into high-frequency trading, which is driving down confidence to all time lows.

The growing perception is that high-frequency trading is creating a market that is no longer fair nor orderly. "HFT is a computer game," one observer said. "It's not about trading shares and staying in them." Last week an order for a stock was entered 100 times in a second and then removed to test the liquidity, he said.

It can be revealed that Shaw Stockbroking has become the latest self-clearer to move to a third-party clearer as the costs of doing it yourself become too onerous at a time when new rules are set to further tie up brokers' capital. At present, stockbrokers who do their own clearing have to stump up $5 million in core liquidity but that will change to $10 million. Before the GFC that sum was only $100,000.

Later this year, cash market margining will be introduced, which will require clearing participants to put aside a certain percentage of every equities' trade on deposit with the ASX for trade date plus three days (T 3 days). The less liquid the stock, the bigger the percentage a broker has to set aside.

While it is designed to make brokers more shockproof in the event of a default, it will put more strain on the smaller stockbrokers (smaller clearing participants) that specialise in trading small-cap stocks. For instance, stocks trading outside the All Ordinaries index with a share price of less than 10? are expected to require a 45 per cent margin. Warrants would require brokers to set aside 22 per cent of the value of the trade for T 3 days.

The Reserve Bank first raised equity margining in a paper on risk management in 2008. It acknowledged it could create liquidity problems for market participants.

Reducing systemic risk is a good thing but it has had some unintended consequences. In terms of the risking costs for self-clearers, it has increased the concentration risk sitting in the system.

There is now one third-party clearer in retail broking, which attaches its own risks. This was nowhere more evident than last year when Penson Worldwide got into financial trouble after investing in dodgy illiquid bonds.

Its Australian business was hawked around and found a home with Pershing, which is a subsidiary of the Bank of New York Mellon. Pershing is a much safer option but the question regulators need to ask is would BNY Mellon stand behind Pershing in terms of the law if anything goes wrong in Australia?

But among all the doom and gloom, there will be benefits. As brokers leave, it will open up opportunities for others.