I have been performing some research on various brokers. Specifically those that retain beneficial ownership of the underlying stock and have some concerns.
Some platform providers (typically those offering low brokerage) allow you to 'Buy Stock' where the transaction is not settled to your personal HIN.
When you buy stock, the purchases are settled against your HIN. Your HIN (Holder Identification Number) is what appears on a certificate that typically, you recieve in the post at the end of the month from the sponsor (ie CHESS) as proof that you are the owner of that stock. If you don't receive that certificate, you don't own the stock.
Now if you buy stock and it's not under your name, for mine, you didn't buy the stock - You simply entered into a zero leverage CFD with the platform provider.
You took on all beneficial ownership risk of a CFD without the potential benefit of the leverage. (You bought into a 'bet' with a financial insititution that likely does not provide transparency into how they risk manage their financial position. A bet that potentially says 'If it goes your way, you win, if it doesn't, we win'.)
Can you obtain a legally binding statement that covers how they hedge to secure your capital? What if the provider goes belly up?
Or are you going on - I saw these guys on TV / In a magazine or newspaper or at a seminar. They seem big so they must be safe....
My real concern is not the providers ability to return your capital when their debts are called in.
My concern is how do they hedge? Especially in small caps.
When you bet price will go up, the platform just took on a risk.
The risk is if the price of that underlying asset goes up, they owe you money so unless their betting on the same asset, I don't see how it can be in their best interest that you win.
If they are betting on the same asset and they hedge against their current position, your purchase does not contribute to price support.
If they are not holding, in a micro where there's no calls/puts/futures etc to use as hedge, the only real hedge I see is the stock itself.
With this, to hedge 100% they need to buy or borrow the stock.
If they buy the stock they put upward pressure on price helping to put you in the money and when you sell the opposite is true.
If they incorporate the liquidity requirements of the hedge into the quote they provide you then it's going to need to be x 2 meaning If you place an order to buy 100K, they hedge 100K, they need to buy 200K to cover the full position & likewise on the sell.
If they borrow the stock, would it be in their best interest that price goes up?
If it goes up they perhaps take a cut on the financing arrangement, spread, brokerage..and loose on stock borrowed & stock borrowing cost.
If it goes down, they take the fees they charged you, pay you nothing or worse, you pay them (CFD type arrangement).
Now one method market making brokers make money is in house trading. Now, if they sold the borrowed stock it would have pushed price down putting them in the money to buy the stock back at a lower price and you pressing the buy button provided them the $ to borrow that stock. You just bought stock using a broker that has an incentive to trade against your position so you could save a few $ on brokerage. In the process the broker reduced hedge coverage increasing the risk on you that you might loose your stock (because the broker that actually owns your stock has an increased risk of going under).
Note: I can think of many other ways such organisation could profit by trading against their clients however my main interest is shorting.
If you have knowledge or experience with such brokers and could shed some light on how they hedge the purchase of micro ASX stocks, feedback would be appreciated.
