The stock market is where securities and stocks are exchanged, typically via a broker. But there is more to market participants than broker-dealers. In fact, all market participants come together to perform their individual roles which in turn help the stock market as a whole run efficiently and to the U.S. Security and Exchange Commission (SEC) standards.
As an investor, it is important to not jump into the market without understanding each of these market participants and the role they play. This will help you mature as an investor while furthering your understanding of the ins and outs of the market.
Who Are the Market Participants?
The stock market attracts corporations and individuals from various backgrounds with one goal in mind – increase wealth. The SEC has been tasked with maintaining standards for a fair, orderly, and efficient market.
To do so, it regulates not only the market, but also market participants. It robustly enforces securities laws and standards, holding wrongdoers accountable to protect investors. The following market participants are regulated through the SEC.
A broker dealer is in the business of buying and selling securities. They can be an individual or a firm and trade securities for their own account or on the behalf of their customers.
A broker-dealer cannot double charge for securities. For each transaction, they can either act as a broker or as a dealer. When acting as an agent, a broker-dealer helps their customer trade securities. When acting as a dealer, they are the one doing the buying or selling on their own behalf. Broker-dealers can only charge a commission or a markup depending upon which role they played during the transaction.
As a Self-Regulatory Organization (SRO), clearing agencies are responsible for writing and enforcing their own rules. There are two main kinds of clearing agencies: clearing corporations and depositories.
A clearing corporation is tasked with handling confirmation, settlement, and delivery of transactions within an exchange. Their purpose is to ensure that all transactions are completed in a prompt, efficient manner. To complete this task, the clearing corporation becomes the seller to every buyer, and the buyer to every seller. They essentially act as the middleman, facilitating the purchases on each end of the transaction.
A depository is an agency that is trusted to safeguard securities certificates and maintain ownership records. Depositories play a key role in trading securities from one investor or another. They are utilized to reduce paperwork and speed up the transfer process. They also eliminate the risk of fraud, theft, loss, or delays with the ownership and transfer of securities.
You have likely heard of the New York Stock Exchange (NYSE), NASDAQ, and the Chicago Board Options Exchange. These are all examples of securities exchanges – the market where securities are bought and sold. There are currently 15 different national securities exchanges that are registered with the SEC.
Credit Rating Agencies
Credit rating agencies play a vital role in the securities industry. They are responsible for providing opinions on the credit quality of securities and companies. The creditworthiness is typically done by a grade and fall into two categories: investment grade and non-investment grade.
Knowing the financial health of a security or company can provide investors with peace of mind. Investment grade ratings mean that the company/security is quality and have a low risk of default. For investors who have high risk tolerance, they might prefer to invest in non-investment grade securities, where the rating shows there might be an issue with debt repayment. However, the higher risk could come with a higher reward – or a total loss.
Persons or firms who provide individuals with investment advice are called investment advisors. Their purpose is to provide their clients with advice and analysis to improve their wealth, in return for compensation for their services.
The SEC regulates investment advisors to protect investors. Becoming a registered investment advisor has specific requirements that include various education and exam requirements, along with federal and state registrations.
The role of transfer agents is pretty straightforward. As their name implies, transfer agents are responsible for recording the changes of security ownership, but their position goes beyond. Transfer agents are also responsible for keeping issuer’s records, issue and cancel certificates, and distributing dividends. They are the middleman between issuing companies and their security holders.
Electronic Communications Networks (ECN)
What was your first memory of securities trading? Large crowds congregating on the stock market floor yelling to buy and sell? Long-gone are the days where the stock exchange was overrun with physical activity. Now, most trading is done through electronic means.
Electronic Communication Networks (ECNs) are the trading systems that match buy and sell orders automatically for their users. With the advancements in technology, ECNs connect brokerage firms with traders, opening up direct trade without a needed go-between. ECNs are classified as Alternative Trading Systems (ATS) and must be registered through the SEC as broker-dealers.
Alternative Trading Systems (ATS)
Any system that performs the functions of a securities exchange that are not registered with the SEC as exchanges are called Alternative Trading Systems. They match buyers and sellers for securities, outside of typical exchanges. All Alternative Trading Systems are required to be registered as broker-dealers.
Self-Regulatory Organizations (SRO)
Self-Regulatory Organizations are formed to regulate, create, and enforce standards and regulations for their industry. They set rules and procedures for their members to promote equality, professionalism, and ethics. Even though they are non-governmental organizations, the SEC can still regulate their organizations. In the securities industry, FINRA is the largest SRO and is responsible for regulating broker-dealers.
A custodian is the company that has possession of your financial assets. This includes banks, brokerage firms, or other institutions that hold your investments and money for security and convenience. Your assets can be stored physically or electronically with a custodian, entrusting them to safeguard the assets to prevent them from being lost or stolen.
Fully Understanding Market Participants
All market participants are responsible for their unique roles in the securities industry. While each plays different parts, they are all connected for the benefit of you, the investor.
If you are unsure of where to begin with the investing market, start with an investment advisor. Their goal is to match you with solutions that are in your best interest to build wealth and a comfortable retirement. They can then walk you through the process of how the role each market participant plays in your portfolio.