BIM56820 | Financial traders - instruments and shares: regulated dealers

How shares and other financial instruments are bought and sold

The actual trading of quoted shares by passing ownership from one person to another takes place on the London Stock Exchange (LSE) through two computerised systems known as SETS (‘Stock Exchange Electronic Trading Services’) and SEAQ (‘Stock Exchange Automated Quotation System’). A person needs to be a member of the LSE to have immediate direct access to buying and selling shares, and such persons are required to abide by the LSE’s rules and be regulated by the Financial Conduct Authority (FCA).

The principal means of trading derivatives and financial instruments on UK exchanges is also now conducted via electronic, screen-based systems, rather than open-access trading floors. Only the London Metal Exchange continues to operate an open outcry floor.

How an authorised dealer operates

A dealer regulated by the FCA may operate as a traditional stockbroker or by offering a service online. Such a dealer will set the price at which he is willing to buy and sell a given share. The difference between those prices (called the ‘spread’) enables the dealer to make money even if the price of the share stands still. The spread is part of the reward the dealer receives for providing a service to customers of the market who want to buy and sell shares. In addition to the spread, dealers can earn commission from customers buying and selling shares and other financial instruments, and also fees by offering advisory or fund-management services.

Thus, while regulated dealers do buy and sell shares to profit from anticipated market movements, it is not the sole way in which they make a profit. Speculation is only part, and a strictly controlled part, of a more complex trading operation. Their operations are designed to make profits whichever way market prices move, by turning over stock as a wholesaler or as a retailer, undertaking many trades on a daily basis.

Moreover, in many cases, an individual dealer will be one of a number employed by a firm or company. This enables the firm or company to set very strict rules about the degree of risk to which any individual trader will be allowed to expose the firm. Additionally, traders may operate, and have expertise in, different markets, so one poorly-performing market may not endanger the firm as a whole.

There is usually little doubt that regulated dealers in this situation are trading and the profits and losses from their transactions in financial instruments will be taken into account in computing the profits of their trade.

Former LIFFE floor traders (or ‘locals’) who made the transition to remote electronic trading continued to be treated as trading unless, on the facts, there was a significant change to the nature of their activities. Similarly, individuals engaged in trading derivatives and financial instruments in the same way as these former locals are treated as trading.