Financial intermediaries help entities achieve their financial goals. These intermediaries include commercial, mortgage, and investment banks; credit unions, credit card companies, and various other finance corporations; brokers and exchanges; dealers and arbitrageurs; clearinghouses and depositories; mutual funds and hedge funds; and insurance companies. The services and products that financial intermediaries provide allow their clients to solve the financial problems that they face more efficiently than they could do so by themselves. Financial intermediaries are essential to well-functioning financial systems.
Brokers, Exchanges, and Alternative Trading Systems
Brokers are agents who fill orders for their clients. They do not trade with their clients. Instead, they search for traders who are willing to take the other side of their clients’ orders.
Block brokers provide brokerage services to large traders. Large orders are hard to fill because finding a counterparty willing to do a large trade is often quite difficult. A large buy order generally will trade at a premium to the current market price, and a large sell order generally will trade at a discount to the current market price.
Investment banks provide advice to their mostly corporate clients and help them arrange transactions such as initial and seasoned securities offering.
Exchanges provide places where traders can meet to arrange their trades.
Alternative trading systems (ATSs), also known as electronic communications networks (ECNs) or multilateral trading facilities (MTFs) are trading venues that function like exchanges but that do not exercise regulatory authority over their subscribers except with respect to the conduct of their trading in their trading systems.
Many ATSs are known as dark pools because they do not display the orders that their clients send to them.
Dealers
Dealers fill their clients’ orders by trading with them.
The service that dealers provide is liquidity. Liquidity is the ability to buy or sell with low transactions costs when you want to trade.
Most dealers also broker orders, and my brokers deal to their customers. Accordlingly, practitioners often sue the term broker-dealer to refer to dealers and brokers.
Broker–dealers have a conflict of interest with respect to how they fill their customers’ orders. When acting as a broker, they must seek the best price for their customers’ orders. When acting as dealers, however, they profit most when they sell to their customers at high prices or buy from their customers at low prices. The problem is most serious when the customer allows the broker–dealer to decide whether to trade the order with another trader or to fill it as a dealer. Consequently, when trading with a broker–dealer, some customers specify how they want their orders filled. They may also trade only with pure agency brokers who do not also deal.
Arbitrageurs
Arbitrageurs trade when they can identify opportunities to buy and sell identical or essentially similar instruments at different prices in different markets.
