Having discussed the need to ensure your cash is secure, and that you are satisfied with the way your cash is held by your stock broker, this week I will take a look at how your shares are ‘held’ by your broker. I will also briefly cover what happens in the CFD and FX markets.
Ownership of shares.
Of equal importance to the question of where your cash is held, is where and by whom your shares are held. This can be in one of two ways:-
1. Registered Shares on a sub-register that are CHESS Sponsored with a client HIN, or Issuer Sponsored with an SRN
A full description of CHESS Sponsored with a Holder Identification Number (HIN) and Issuer Sponsored with a Securityholder Reference Number (SRN) is provided at this link on the ASX website:
http://www.asx.net.au/products/shares/how/chess_benefits.htm
You own ‘Registered Shares’ when your name, or your entity’s name, is recorded on the share registry of the listed company in which you have invested. Registered Shares give you legal ownership of the shares and the rights associated with being a share holder of an ASX listed company.
Of the online brokers who facilitate trading ‘exchange traded’ Registered Shares on the ASX and whom are ASX Participating brokers, Commsec, E*TRADE, Westpac, NAB and Macquarie Bank are probably the most well known. This system is not unique to Australia as international exchanges do offer an ‘exchange traded’ registry based system. The majority of full-service brokers are also ASX participating brokers.
2. Shares that do not have a HIN or SRN in your trading entity’s name
It is possible to ‘hold’ shares that may not be held with a HIN or SRN in your name. The unknown in such a case is who the ultimate legal owner of the share assets really is. This may depend on confidential contractual agreements between any and all parties involved in brokers’ transaction processes.
Investors need to be aware that the broker-related risks involved with holding shares that are not CHESS Sponsored with a HIN or Issuer Sponsored with an SRN are greater than if the holdings do have a HIN or SRN in the name of your trading entity.
The broker-related risks could be spread across multiple third party organisations with which the broker needs to have a relationship to facilitate the trading of the instruments that they offer. In the case of holding a share that does not have a HIN or SRN in your name, you could be exposed to the risk of other organisations failing with which you have no direct relationship. You will probably not know or be aware of these complex relationships until such time as they unwind, as has been the case with several brokers since the GFC.
What happens to shares in the event of a default by the broker?
In the case of Registered Shares, the owner on the share registry for a particular listed company has legal ownership of Registered Shares. As such neither the broker nor any associated third party with which the broker may have a contractual relationship has any legal or beneficial right to the registered shares if your broker goes into liquidation, unless you have pledged these through a ‘lien’ or ‘charge’ to a margin lender.
If shares are not registered on a listed company’s share registry with a HIN or SRN, then these shares can potentially be viewed as the assets of the defaulting broker and may be used by liquidators to settle outstanding creditors of the defaulted broker. As a potential unsecured creditor you could be amongst the last to be paid.
CFDs, futures and FX
Those that wish to trade CFDs, futures or FX must be aware of the risks associated with trading such instruments by making themselves acutely aware of the information described in the respective brokers’ PDS documentation. Be aware that all potential risks cannot be totally eliminated and that the degrees of risk can vary from one broker to the next.
As I have publicly stated in the past, investors who would like to trade leverage should invest a maximum of 15-20% of their total market related capital into any leveraged strategy but preferably less, and more like 10%.
Strategy aside, similar principles in relation to limiting capital to user-defined percentage levels should also be applied to depositing investing capital with a provider that facilitates the trading of shares that do NOT have a HIN or SRN.
Conclusion
It is the responsibility of each investor to understand the risks associated with choosing the broker that they wish to transact with. However, different brokers offer different lists of instruments that can be traded and hence the investor needs to match their risk profile to the benefits and the potential broker-related risks of any broking solution that they may consider using.
From our research it was clear that the most secure manner for investors simply trading unleveraged stocks through their self managed super fund, or any other entity, is to do so through a broker that offers the trading of Registered Shares with a linked CMA or CMT for the unallocated cash. Even so, risks, as minor as they may seem to be, still exist during the clearing process or with the Australian bank defaulting.
Those trading CFDs and other synthetic instruments should consider choosing an online broker that you have thoroughly researched. Ask the necessary questions about their product disclosure statements (PDS) and how secure your assets will be when deposited with them, particularly in the event of their default. If you don’t get the answers you’re looking for then keep looking for another firm to deal with.
This article gives good advice, but there are areas of far greater risk due to a third-world level of incompetence which investors would scarcely believe. I held shares in a gold miner, CHESS registered, with my HIN allocated to the holding. I then subscribed to a rights issue for which the date for listing of the new shares was “in due course”. Weeks and months went by. I enquired from the company and was ignored. I wrote to the Aust Stock Exchange who one would think might be interested in the accountability of member companies, but was totally ignored. Finally I had to resort to the ASIC who did act.
It was revealed that my shares had been issued by the share registry to a person of the same first and last name as me. (I had heard of this person 30 years ago, as someone known to the police). He had immediately sold the shares, with no questions asked, and pocketed the money. The share registry had ignored the different address, and most importantly, ignored the data which we are all supposed to regard as our impenetrable wall of integrity, namely the HIN number.
If the GFC hasn’t proved it for us, it is obvious that our schools have failed for years to provide people with any clerical literacy and governance at all levels in this country is just a joke.