Money: A rough deal from electronic trading

A Beginner's Guide To; Investing In Shares: Traditional share certificates are a thing of the past. Magnus Grimond looks at the future
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The Independent Online
In This series on stock market investment for beginners, we hope to have led would-be investors through some of the jargon and unfamiliar concepts of buying shares and gilts. But many may still find the mechanics of dabbling in the markets more than a little offputting. Stockbroking now abounds with acronyms like Crest, Sets and, even worse, CGO2. Newcomers will need some help, but even those familiar with the old dealing methods will find that the landscape has changed completely over the past few years.

Once upon a time the process of owning shares involved possessing a share certificate. This was often a thing of great beauty: some of the pre- revolutionary Russian issues or Chinese stocks are now highly prized among collectors - called scripophilists. Sadly, the 20th century has caught up with the stock market and shares are now largely transferred from buyers to sellers electronically, as gilts have been for 10 years or more.

It is still just possible to hold shares in paper certificate form, although cynics would argue that the main aim of recent "paperless" settlement innovations is to dematerialise the small shareholder along with his certificates. That, however, is a charge strenuously denied by Crest, the shiny new share-settlement system set up by the Bank of England.

Under the new system, the key point for certificate-holding shareholders is that whereas dealing was formerly done in leisurely two or three-weekly accounts, now it must all be tied up within five days. That puts a premium on the investor having the share certificate or cash immediately to hand as soon as the deal has been done by his stockbroker. This timing pressure will grow even more acute if plans to reduce the settlement period to three days are implemented.

Around 100,000 of the 130,000 daily share transactions carried out in London are now processed electronically, with 80 per cent of UK listed companies by value operating within the new system. Crest says it is not trying to squeeze out investors who wish to hang on to their certificates. The reality, however, is somewhat different.

To go fully electronic, a small investor must dump his paper and either be willing to see all his shares held through a nominee account run by his broker or get the broker to "sponsor" him as a member of Crest. The former is deeply unsatisfactory, as direct communication between the company and the shareholder is cut off, so the investor does not get annual reports and dividend statements and is not entitled to perks such as shareholder discounts on the company's products. The alternative, sponsored membership, for which Crest charges pounds 20 a year, has clear advantages and has already been taken up by 1,800 private investors. But while the traditional links with the company are maintained, you could find yourself being charged extra for the service. There is also much greater pressure to channel all deals through one broker.

Part of the justification for all this aggro is Sets, the Stock Exchange Electronic Trading Service. Traditionally the stock market has been operated by a number of "market makers", who acted like the stallholders in a fruit and veg market, buying shares at one price and selling at a higher one. Under the new system, most of the share trades involving companies in the blue- chip FT-SE 100 index are automatically matched on an electronic "order book" without the need for a market maker to buy and sell in between.

In theory this should cut costs and reduce the money lost in the spread between buying and selling prices. In fact, Sets has resulted in huge volatility and comes up with some pretty odd prices, particularly early and late in the day when big deals are thin on the ground.

Small investors are protected to an extent because bargains worth less than pounds 2,500 to pounds 5,000 in effect continue to be dealt with on the old basis through four market makers, known as retail service providers. Even so, trades completed this way must still reflect Sets prices. If they are themselves wonky, the investor could suffer, particularly if he deals with an execution-only broker who is obliged to deal as soon as possible, rather than waiting for the market to settle down in the middle of the day. One other niggle about Sets is that investors who for some reason cannot or do not want to settle within the five-day standard settlement period may find themselves penalised with a worse price. This is likely to have a particular effect people with certificates.

The other big market change to excite controversy is the Bank of England's system for settling gilts transactions, known as CGO2 from the initials of the Bank's Central Gilts Office. This shares similarities with Crest, notably that investors willing to put their holdings into a nominee or sponsored membership account will see an improved service, including next-day settlement. The problem is that, yet again, holders of certificates are penalised. Ten-day settlement is now the norm for the 50 per cent of gilts investors still using paper.

It seems clear that small shareholders will be pushed into electronic settlement and dealing whether they like it or not. In the same way that credit and debit cards have been replacing cash, this will no doubt be more secure and convenient, particularly for frequent dealers. The drawback is that the expense and complication is likely to put off some people. That is a shame because both diversity and the cause of wider share ownership will be victims. For most of us, though, it will probably just be a case of if you can't beat them, join them.

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