The US Stock market is the largest in the world accounting for under 50% of the market capitalization of all listed companies around the globe. With millions of shares traded every day and thousands of active investors, the US stock market is a volatile place.
Back in 1929, when the US markets crashed (The Great Depression), investors lost confidence in the markets. As the government analyzed the crash and tried to identify the problems, it discovered that the markets needed transparency and regulation. Hence, the US Securities and Exchange Commission (SEC) was created. The primary objective of the SEC was to protect investors, ensure that the markets function in a fair and orderly manner, and facilitate the formation of capital.
To meet these objectives, the SEC assumed a pivotal role in controlling and regulating all participants in the stock markets. In the US, there are the following intermediaries:
Let’s take a detailed view of each intermediary.
In the US, a broker-dealer or B-D is a financial entity that can trade securities for itself or on behalf of its clients. When it buys or sells securities in its name, it becomes a dealer. On the other hand, when it executes orders on behalf of its clients, it functions like a stockbroker. In the US markets, the B-D fulfils many critical functions including:
There are two types of broker-dealers in the US:
A clearing agency is an entity that facilitates the settlement of a trade in the stock market. According to Section 3(a)23(A) of the US Securities Exchange Act, 1934, a clearing agency is:
“Any person who acts as an intermediary in making payments or deliveries or both in connection with transactions in securities or who provides facilities for the comparison of data respecting the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities. Such term also means any person, such as a securities depository, who
When a stock is bought or sold, the market needs to ensure that the buyer receives the stock and the seller receives the money within a stipulated time. This is where clearing agencies step in. There are two types of clearing agencies in the US:
Clearing corporations Clearing Houses or Clearing Firms are organizations that handle the confirmation, settlement, and delivery of transactions in the stock market. Their primary responsibility is to ensure the efficiency of each transaction.
They ensure this by becoming a buyer for every seller and a seller for every buyer and assuming an offsetting position in every transaction. So, when a trade takes place in the market, the clearing corporation becomes the middle-man and facilitates purchase at one end and sale at the other. Additionally, clearing corporations regulate the delivery of securities and report data relating to trading activities.
The Depository Trust Company (DTC) is the largest securities depository in the world. It provides safekeeping of securities via electronic record-keeping. It also assists in transferring ownership and maintains updated ownership records of all companies registered with it. The DTC operates through a network of participants like banks and broker-dealers.
A credit rating agency analyzes the financial strength of a company or entity and assesses its potential to repay the interest and principal on its debts. The rating provided by the agency is an indicator of how confident it is about the borrower honouring its debt obligations as per the terms of the debt. In the US, the credit rating industry has three major players:
Together, these agencies control around 95% of the global credit rating business. They help create a sense of comfort for investors by providing an unbiased and independent evaluation of the creditworthiness of a security.
Investment banks play a crucial role in handling the Initial Public Offering (IPO) of stock when a company decides to go public for the first time. When a company decides to launch an IPO, it approaches an investment bank to function as an underwriter of the IPO. The bank researches and analyzes the company’s financials and manages the issuance of shares after considering the percentage of ownership that the company wants to relinquish. The company pays the investment bank a fee for its services and an assurance of a minimum price per share.
Electronic Communications Networks or ECNs are electronic trading systems that are designed to automatically match buy/sell orders at specific prices. Individual investors cannot place an order with an ECN directly. They need to have an account with a broker-dealer to route their orders to an ECN. However, apart from broker-dealers, institutional investors and market makers can place their orders directly with this automatic system. Usually, orders placed in the ECN are limit orders.
An Alternative Trading System or ATS is a trading system that meets all the requirements of stock exchange but is not required to register as one if it operates under the exemption provided vide Exchange Act Rule 3a1-1(a). ATSs are regulated as broker-dealers as opposed to stock exchanges. They offer an alternative option for accessing liquidity and can be used to trade shares away from the normal market.
Securities exchanges are marketplaces where investors buy and sell securities. When a company launches shares, it chooses the exchange(s) on which it wants them listed. Investors can buy or sell stocks only from the exchanges where they are listed. In the US, there are many securities exchanges that are registered with the SEC:
Every stock exchange has a primary market where the IPOs are launched and a secondary market where shares listed after the IPO are traded.
Transfer agents are responsible for recording changes of ownership of a security, maintaining records, distributing dividends, etc. They are the liaison between the company and the security holders. Hence, they play an important role in ensuring efficient trades in secondary markets. The SEC regulates the transfer agents and ensures that they facilitate prompt and efficient settlement of security transactions while keeping them secure.
A Self-regulatory organization or SRO is a non-governmental entity that regulates various market entities on its own. Despite being private organizations, the government has reasonable regulatory control over them. SROs primarily function as watchdogs for the markets and guard against fraudulent activities or unprofessional practices. Securities Exchanges and Clearing Houses are classic examples of SROs.
Two important SROs that you must know about are:
The core structure of the US stock markets is similar to the Indian stock markets. While some terms and regulations might differ, the role of Financial Intermediaries in the US Stock Market is to ensure that the capital markets remain investor-friendly and safe to help the generation of capital. Being the largest stock market in the world, the US needs stringent laws and regular monitoring to keep miscreants and errors away. With this network of intermediaries and a tight regulatory framework, the US markets are dependable to a great extent.