Hard times for broken brokers

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 sharemarket volumes.

Speculation aside, their departure is a symbol of the growing turmoil that is enveloping the Australian stockbroking industry.

People are either leaving or being made redundant some 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 takeover bid by Mariner Corp. Wilson HTM is trading at 19.5? a share, after trading above $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 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 the current 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 are complaining that the phones hardly ring, particularly as self-managed super funds have been parking more and more of their money into cash and bonds and out of equities.

There is, no doubt, a changing mindset taking place. The cycle of equities has changed post GFC and the sovereign debt crisis. To further complicate matters, more and more investors are going for the cheaper online option to do their trading, which doesn't provide advice, and other bigger investors are moving more and more into high-frequency trading, which is driving confidence to all-time lows. The growing perception is high-frequency trading is creating a market that is no longer fair or orderly. As one observer said: "HFT is a computer game, it's not about trading shares and staying in them." He said last week an order for a stock was entered 100 times in a second and then removed to test the liquidity.

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 move to $10 million, after being $100,000 before the GFC.

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 plus three days (T 3). The less liquid the stock, the bigger the percentage a broker will have to set aside to reflect the risks.

While it is designed to make brokers more shock-proof in the event of a default, it will put added strain on smaller stockbrokers (smaller clearing participants) who 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.

The Reserve Bank first raised equity margining in a paper published 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 created some unintended consequences in a number of areas. In terms of the risking costs on self-clearers, it has increased the concentration risk sitting in the system.

There is currently one third-party clearer in retail broking that 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 whether the Bank of New York Mellon would stand behind Pershing in terms of the law if anything goes wrong in Australia.

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

aferguson@fairfaxmedia.com.au