ONLINE TRADING IN THE UNITED KINGDOM
The present level of online trading is low. Online investors constituted roughly 3% of retail investors and online trading contributed 20% of total trades using execution-only broking services. The penetration of online trading among UK investors is relatively low vis-à-vis European counterparts.
Online trading is mainly offered in execution-only broking services for mainly retail investors. Advisory dealing services and discretionary broking services involve investment advice and portfolio management for which online trading is not applicable.
Marketing strategies of online brokers are mainly focused on attracting new customers rather than shifting the trading mode of existing customers.
Possible measures for promoting online trading include: reducing overall costs to boost market trading generally, efforts to change investor behaviour and attitudes, and enhancement of online services.
CONTENTS
1. Introduction ... 2
2. How online trading operates ... 2
3. Regulation of online trading... 4
4. Market players in online trading ... 5
4.1 Investors and their attitude towards online trading... 5
4.2 Online brokers... 6
1. INTRODUCTION
In the United Kingdom (UK), online trading whereby orders are placed directly via electronic channels by investors into the broker system is an automatic straight-through process, i.e. the orders are routed automatically to the exchange’s trading system or the dealing systems of the market makers. However, placing orders via e-mail to the broker who then re-inputs the order manually to the trading system is also known as “online trading”. At present, the Internet is the most popular online channel.
A major step in the process of developing online trading in the UK was when Charles Schwab Europe, the first online broker in the UK set up by a US broker firm, launched the service in June 1998.1 It is a service offered mainly to retail investors. Both equities and derivative products2 can be traded online in the UK. Ever since the introduction of online trading, online brokerages in the UK have focused on equity trading.3 Trading other types of securities or structured products such as mutual funds or traded options via online media is not popular.
From the limited statistics available, the level of online trading in the UK is not high and its development is not free of obstacles. These are discussed in the following sections.
2. HOW ONLINE TRADING OPERATES
In the UK, there are three types of broking service to investors, namely execution-only, advisory dealing and discretionary broking. Investors using execution-only broking services will make all the investment decisions and simply give buy/sell instructions to the broker. Investors can communicate with the broker by post, telephone or Internet. In advisory dealing, the broker will listen to the investor’s ideas and offer advice or make recommendations about what the investor should buy or sell. Advisory dealing services cost more than execution-only services. Most expensive of all is discretionary broking where the investors delegate all investment decisions to an investment manager. The investors will not be consulted at all in the decision making process. All online trading services available in the UK are execution-only, which means that all investment decisions are left to the investor without broker advice.
Before the introduction of online trading, the major order-placing channels for execution-only trades were telephone and post. While execution-execution-only trades now commexecution-only use online trading, order-placing by telephone is more popular for advisory dealing. This is because the “human touch” is crucial in advisory services and communication via telephone is one of the best ways for the brokers to cultivate a strong relationship with customers. Nowadays, some brokers still accept orders by post.
1 Based on information obtained from the website of Charles Schwab Europe.
2 Derivative products here largely refer to those traded on London International Financial Futures and Options Exchange (LIFFE).
3 This can be explained by the low retail participation in the trading of derivative products. For instance, retail participation in LIFFE is known to be limited. Equity-related derivative products have been somewhat more popular among the retail investors, but they still contributed only 5% of LIFFE’s individual equity derivatives volume in 2001.
There are two types of online service: e-mail based and real-time dealing.
In the early stage of development, e-mail based online trading services were offered to investors as an alternative way to contact the broker. Instead of calling on the telephone, investors can place their orders via e-mail. When the broker reads the e-mail, he/she will input the orders into the exchange’s trading system. E-mail is obviously faster than post but such service offers little attraction over the existing telephone-based trading arrangement.
Since the end of 1998, some brokerages offer investors electronic channels to place their orders directly — real-time dealing service. Real-time dealing service involves routing of investor orders automatically to the exchange’s trading system or the dealing systems of the market makers on a straight-through basis. Once the order is successfully executed, the investor will receive an online confirmation note within seconds. At the same time, the broker will deduct the commission charge and a stamp duty of 0.5% for each order. At present, real-time online trading is among the cheapest in the marketplace in terms of cost-efficiency. Among the online media, it appears that Internet trading is the most popular.
Most real-time dealing brokers offer such trading service for trading UK-listed stocks only, that is stocks listed on either the London Stock Exchange (LSE) or the Alternative Investment Market (AIM). For other securities like selected unit trusts and OFEX4 stocks, some brokerages offer online trading while others do not.
Investors in the UK can hold their shares in the form of either physical share certificates or electronic shareholding. In the past, most investors held physical share certificates. Investors hold physical share certificates in “certified accounts”. Electronic shareholdings are mainly held by nominee companies in “nominee accounts”.5 To date, most brokers would encourage their clients to hold their shares electronically using nominee accounts. Both Barclays and Redmayne Bentley allow clients to deal over the Internet while continuing to hold physical share certificates. Charles Schwab however insists on electronic holdings in nominee accounts.
4 OFEX is an off-exchange market providing a share-trading platform for unlisted and unquoted securities. The OFEX market is a Prescribed Market under the Financial Services and Markets Act 2000 and is directly regulated by the Financial Services Authority (FSA).
5 Nominee accounts are in the name of companies which hold shares on behalf of one or many investors. In other words, the nominee company’s name, instead of the investor’s name is entered into the company's register as the owner of the shares - but investor’s rights as the beneficial owner are protected under law. However, the investor will lose all direct communication with the issuer. There is a third type of shareholding account - CREST-sponsored member account. CREST is the clearing company for UK-listed equities. Holding a CREST-sponsored member account is the fastest way to trade shares and is also the most expensive way as investors have to pay the stock exchange and the broker for services. In return, the investor is in effect registered as a trader and as a shareholder for direct communication with the issuer of the shares he/she holds. This type of account is more appropriate for investors who trade very frequently.
3. REGULATION OF ONLINE TRADING
In the UK, only authorised persons under the Financial Services Authority (FSA) are allowed to operate securities business and to issue an investment advertisement in the UK. An authorised person must be a member of a self-regulatory organization, e.g. the exchange.
Currently, the FSA is responsible for regulating stock trading in the UK. The Financial Services Act 1986, which was replaced by the Financial Services and Markets Act 2000 (FSM Act 2000), applies to the Internet and other online media6 as it does to other order-placing media. Practitioners are required to obtain authorisation from the FSA to carry out online investment business, for which services or advertisements are made available in the UK via the Internet. In 1999, regulatory guidelines were issued to deal with the situation that a web site constitutes an investment business or offerings of securities.7 The FSA is responsible for monitoring these online investment service providers to ensure that they have robust systems and controls to minimise the business risks to customers. According to the FSA, it will take formal action if significant problems persist in a firm.
The maintenance of market integrity in the presence of online trading is also outlined in the FSM Act 2000 which was passed by Parliament in December 2001.8 According to the FSM Act 2000, in the course of regulating financial services including online trading, the FSA will focus on:
(1) building up market confidence; (2) raising public awareness of
(i) benefits and risks of different kinds of dealing and (ii) provision of information and advice by brokers; (3) strengthening investor protection;
(4) reducing financial crime.9
With the FSM Act 2000 in force, it is expected that it will be easier for UK investors who have suffered from Internet fraud or mischief to bring a case to the court.10
6 In the UK, the Internet itself as a medium for activities and communications is unregulated. Anyone, from anywhere, can offer investors anything for sale.
7 The guidelines state that website providers who are unlikely to be regarded as operating an investment business are those who (i) have no knowledge or control over the materials provided on the site; (ii) do not promote another person’s services and merely act as a conduit and where the services are not promoted in its name. Accordingly, maintaining a website in the UK may be regarded as operating an investment business or offering securities in the UK. The guidelines also state that any material which is an “investment advertisement” disseminated over the Internet will be deemed to “have been issued in the UK if it is directed at people in the UK.”
8 “UK threatened by web fraud”, by Chris Lee. Yahoo! Headlines on 4 January 2002.
9 These are extracted from the speech “Online securities trading conference, 6 June 2000” delivered by Michael Folger, Director of Investment Business of FSA.
4. MARKET PLAYERS IN ONLINE TRADING 4.1 Investors and their attitude towards online trading
According to the Association of Private Client Investment Managers and Stockbrokers (APCIMS)11, online investor accounts have grown from 31,000 in March 1999 to 155,000 in 2000 and to 327,000 in September 2001, i.e. by 9.5 times in two and a half years. Rapid growth in account opening is witnessed. As of September 2001, online trades conducted by these investors accounted for 20% of total execution-only trading volume.
Yet the number of online brokerage accounts is low in the UK in comparison to other European countries such as Germany and France (Table 1). According to the study conducted by JP Morgan, Germany had the largest online client base, accounting for 51% of online investors in Europe in 2000. The UK lags behind its European counterparts, sharing only 8% of total European online accounts.
Table 1. Number of online investors in Europe (Unit: million)
Country 1997 1998 1999 2000 2001E 2002E
Germany 0.2 0.4 0.8 1.9 2.4 2.8 France 0.1 0.1 0.1 0.4 0.5 0.6 Sweden 0 0.1 0.2 0.4 0.5 0.6 UK 0 0.1 0.1 0.3 0.4 0.4 Italy 0 0 0 0.2 0.4 0.5 Netherlands 0 0 0.1 0.2 0.3 0.3 Spain 0 0 0 0.2 0.3 0.4 Switzerland 0 0 0 0.1 0.1 0.2 Total 0.3 0.7 1.3 3.7 4.9 5.8
Note: "E" stands for estimates.
Source: Europe's online brokerage indsutry 2001, JP Morgan.
While comprehensive investor statistics are not available, the survey “Online Trading Research” conducted on selected target groups by ProShare in 200012 may shed some light on the trading preference and attitude of UK online investors. The survey found that 30% of the respondents claimed to have traded online. They mostly preferred trading online via electronic communication devices such as PC at home for security reasons. More than 70% of the respondents claimed that cost is the most important factor when selecting a broker. Among those trading online, speed of order-placement is the most important; and more than half of online traders claimed that they would become more active in the market. For respondents not trading online, concerns about the security level and convenience of placing orders by phone are the two popular reasons.
11 APCIMS represents the majority of private client stockbrokers and investment managers in the UK who trade for more than 12 million individual shareholders in the UK. The surveys it released were primarily about retail investors.
12 The survey results were released in February 2000. The target respondents were chosen from the purchasers of books about online trading and attendees of online trading courses and exhibitions. A sample of 427 people were interviewed.
4.2 Online brokers
In the UK, although many broker firms have a presence on the Internet, only a handful of brokers offer online trading services. APCIMS has around 150 members offering stockbroking services and of them only around 40 offering online trading services to investors.13 The leading online brokers include Charles Schwab Europe, Stocktrade and Barclays Stockbrokers.
Since the development of online broking in the UK is still at an early stage, brokers have focused their efforts on attracting new online investors rather than enhancing their services offered to existing investors. Apart from the general services offered (including research analysis, real-time information and data), brokers attract customers by offering competitive service pricing and special offers to new customers or to existing customers who make account opening referrals. For instance, Hargreaves Lansdown offers 30 days’ trading at a reduced flat rate of £4.95. Jarvis offers to pay £75 into each new account. Comdirect even paid £150 into each new account14 and rewards its existing clients (£50) for introducing friends to open an account and conduct their first online trade via Comdirect. Many leading broker firms, such as Charles Schwab, DLJdirect, E*Trade and TD Waterhouse, offer a free dealing period varying from a fortnight to one month for any new account opening. Some others include real-time quote search as part of their service package.
Online trading service charges vary from broker to broker, and from service to service. Some brokers offer variable commissions, others are fixed. Some will charge nothing other than dealing commission while others have additional charges.
5. OUTLOOK OF ONLINE TRADING IN THE UK
If comparison is made between the estimated 0.4 million online investors15 and the more than 12 million retail shareholders served by the members of APCIMS, online trading in the UK cannot be considered popular as about 3% of all retail investors in the UK appear to have traded online. To expand the existing online investor base and the popularity of online trading in the UK, the following may be considered.
(1) Measures to boost trading
Cost-reduction measures to stimulate market trading as a whole would also be conducive to the development of online trading. The effects on online trading would probably be greater given that investors using execution-only services would be more cost-sensitive. Possible ways include a reduction in stamp duty which is currently 0.5% of the transaction value.
13 This is based on the member list posted on the APCIMS website. Also it should be noted that some of the members do not offer execution-only trade service which means online trading service will not even be considered by them.
14 But the firm has stopped giving out this offer, yet investors could register for invitations for a new offer next year.
The promotion of margin trading is another possibility. Margin trading, i.e. trading on credit, practically does not exist in the UK. The reason quoted by brokers is that investors are not interested in such service. Margin trading allows investors to leverage their investment by borrowing against securities held within their account. Should this be successfully promoted to the investors, it might encourage more trading.
(2) Understanding investor behaviour
Compared with other European countries like Germany and France, UK investors seem slow in moving to online trading (Table 1). And yet half of UK adults claimed to have used the Internet and 45% of the UK households claimed to have Internet connections.16 In principle, all execution-only trades could be done online but currently only 20% of them are. Reasons for the low investor acceptance would have to be explored by interested parties concerned. More promotion of online trading may be needed and investor attitudes towards online trading may have to be changed.
(3) Lower costs for trading online
This is the main battleground on which most online brokerages providing execution-only trade service are competing against one another. Generally speaking, reduction in transaction costs is a major reason for moving online. Very often, trading online is not necessarily much cheaper than telephone services if manual assistance is required to execute the orders, i.e. “online trade with human intervention”. However, there is an estimate that if an average of 10 trades is made per year, an investor can save at least £100 by moving from telephone trading to genuine online trading.17 Thus, trading online does benefit the frequent traders.
(4) Enhancing online services
Some online brokers have been using special offers to attract new clients. To a certain extent, these offers work more to the advantage of investors than the brokers. For instance, many investors open accounts just to take advantage of the special offers and then move on to another broker, leaving a defunct account with the former broker. This constitutes an administrative burden to the former but brings in no revenue.18
As mentioned by an application system provider, in addition to the basics of online trading, investors are expecting more associated online services. Real-time online news and more sophisticated asset allocation tools will become the prerequisites for providing online trading service. According to the analyst at Self-Trade in the UK, “It is difficult for customers to differentiate between the brands. I think the products that will make the difference are the value-added tools such as research and portfolio modelling tools.”19
16 “Key trends in fixed and mobile telephony, and Internet”, published in 2002, Office of Telecommunication, UK.
17 “Online investing – Virtual insanity”, Investors Chronicle, 22 June 2001.
18 “Fancy deals – innovative offers catch clients”, Investor Chronicle, 30 November 2001. 19 “Online brokers prepare for a period of consolidation”, Financial News, 19 November 2001.
To retain their customers, brokers have to provide more comprehensive services. These services may include: (1) providing greater access to overseas markets; (2) broadening the product line; (3) providing multiple channels for a trading, e.g. apart from Internet, channels such as WAP and digital TV together with physical call centres and branches. Further to this, a number of UK brokers are establishing drop-in investment centres to complement their online services.20 This trend appears likely to continue.
According to ComPeer, Self Trade attracted numerous new online broking accounts in the third quarter of 2001. Self Trade did not attribute this success to its special offers to new investors. Instead, it believed that its success was due to developing a simple service and gradually adding more sophisticated functionalities.
Looking forward, industry observers believe that there may only be room for 20 players in the online business.21 Many analysts expect the market to polarise between the larger, global players such as E*Trade, Charles Schwab in the UK, and the niche operators such as Internaxx, which targets offshore investors. In fact, the online brokerage industry in Europe is undergoing consolidation and many brokerages may leave the market.22 Brokers intending to maintain a presence in the online market will need to have competitive edge over others.
20 “Online stockbroking – New Horizons – New Development in Online”, Investor Chronicle, 16 November 2001.
21 “Online brokers prepare for a period of consolidation”, Financial News, 19 November 2001.
22 In the last quarter of 2001, some brokerages, including Merrill Lynch HSBC, announced that they would limit their expansion of online trading business. Credit Suisse First Boston (CSFB) planned to sell its online broking service.
References
1. All change Europe’s big players, Funds International, 30 November 2001.
2. Fancy deals – innovative offers catch clients, Investor Chronicle, 30 November 2001. 3. FSA guide to financial advice, Financial Services Authority (FSA).
4. More popular than football; online stock trading popularity, Chemistry and Industry, 5 November 2001. 5. Online brokers prepare for a period of consolidation, Financial News, 19 November 2001.
6. Online investing – Virtual insanity, Investors Chronicle, 22 June 2001.
7. Online investing – Netting Investor Confidence, Investors Chronicle, 10 August 2001.
8. Online securities trading conference, 6 June 2000 delivered by Michael Folger, Director of Investment Business of FSA
9. Online stockbroking – New Horizons – New Development in Online, Investor Chronicle, 16 November 10. ProShare On Line Trading Survey February 2000 by ProShare.
11. Stocks away! by Sally Wright, Charterhouse Communications, What Investment. 1 December 2001. 12. UK threatened by web fraud. by Chris Lee. Yahoo! Headlines on 4 January 2002.
13. Websites of online brokers which include Ample, Barclays Stockbrokers and Charles Schwab.
