Capital requirements for brokers under review

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In July, the ASX released a Consultation Paper regarding 'Changes to Clearing Participant Minimum Core Capital Requirements Approach'.

Translation: how much cash a broker needs to hold in its account at any time.

The necessity for core capital requirements has been around for a while and arises because when you execute a trade through your broker, they undertake the trade on your behalf and then the trade is settled between the broker and you a few days later.

While brokers have had to hold a cash balance to execute these trades for quite a while now, the ASX has proposed changes based on the level of activity as well as the type of activity the broker undertakes.

The new measures will require all market participants to hold at least A$5 million in cash reserves. However, this can increase to A$20 million depending on whether the broker engages in client-written options clearing, trading on its own account or non-ASX client activity.

For many of the larger brokerages, the impact of these proposed changes would be minimal given the volume of trades executed and the fact they probably already carry these cash reserve levels.

Where it would be an impost would be on the boutique broking houses that engage in a range of business functions, particularly including non-ASX work and trading on their own account.

The danger is that these firms either curtail the other parts of the business, leading to the potential for higher fees for investors, or they increase the level of cash reserves at the expense of investors through higher fees.

More than likely, this could see another round of consolidation at the smaller end of the broking spectrum as those firms join up or get swallowed up by the big players.

Concentration of brokers has the effect of limiting choice for both investors and listed companies that are raising equity. Scarcity and concentration can lead to distortions in the market, whereby the quality decreases and prices increase.

The consultation period has just closed, so we look forward to the response of the market and whether these proposals will be rolled out in the new year.

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