CRITERIA OF MARKET QUALITY FROM THE POINT OF VIEW OF THE PROVIDERS OF RELEVANT FINANCIAL SERVICES

CRITERIA OFMARKET QUALITY FROM THE POINT OF VIEW OF THE PROVIDERS OF RELEVANT FINANCIALSERVICES

Up to this point it has repeatedly been assumed that the

costs that depend on the organization of the market can

be reduced to zero, without the services in question

being waived. Of course, this is unrealistic. On stock

markets, just as anywhere else, it is hardly possible

to provide services free of charge. Investors and

issuers will therefore regard as efficient those stock

markets on which the appropriate financial services are

provided in the most rational way and on which

competition is strong enough for the benefits of

efficient production to be reflected in prices.

It is well known that in many countries  security-dealing 

firms reject price competition. Commission cartels in

security dealing are among the oldest and most success-

ful price-fixing arrangements in business history. As

the long and intensive debate about the dissolution

of the commission cartels of the members o/: the principal

stock exchanges in the United States has shown,

 there are no valid reasons why such cartels

should be allowed to continue in existence. If the

principle of competition among providers of financial

services on stock markets was accepted, their interests

would then lie in the same direction as the interests

of investors and issuers. They would, like firms on

other markets, try to offer services which in quality

and price were attractive to certain investors and

issuers and to this end they would use the most

efficient production procedure. The criteria of market

quality  for them would then be freedom to choose

their products and range of products, freedom of

pricing, and freedom in the choice of production

techniques.

Given these three freedoms a broker, for example,

will be able to execute a client's order as

inexpensively as possible: he can offer the client

the plain transaction service, he is free to conclude

the contract in the manner that is cheapest for him

and he can in every case charge a fair market commission,

But stock exchange members are not always allowed to

accomodate investors in this way. In many cases they

have to pass an order through the stock exchange even

when the price and the other party to the transaction

have already been established and must charge a higher

commission than competitive conditions warrant; they

therefore offer the client, in addition to the

desired dealing service, "free" consultancy and

custody services although the client would possibly

be better off if he were able to buy these services

from specialized firms with the portion of the

commission he had saved.

It would be a mistake to suppose, however, that the

mechanism of competition can immediately and unaided

bring about an alignment of the interests of investors

and of financial service organizations and thereby

automatically introduce a maximum level of procedural

efficiency, even though for some financial services

that result can certainly be expected. Four categories

of stock market financial services must be distinguished

in this context. The first group of financial services is characterized by the fact that even an individual firm can provide and sell such services with a prospect of beingable to withstand the competition. Included in this category are advisory or counselling services, the

publication and distribution of information from

issuers to investors, the acceptance and transmission

of orders, and the maintenance of clients' accounts.

In this area there can be competition among individual

firms. There are many firms that have been successfully

offering such services for many years - and, naturally,

examples of failure are also to be found.

Financial services of this first type must be strictly

distinguished from those services which, although also

sold for a consideration, can be provided so cheaply

where there is co-operation between the largest

possible number of firms that a lone operator has no

chance of being able to survive the competition if his

services are provided by others on a joint or centralized

basis. Among services of this type may be mentioned the

provision of information on current buying and selling

prices, the clearance of securities transactions and

basically also the finding of the counterparty to a

transaction. Although single firms can compete in this

field as far as the fees they charge are concerned,

individually they have no influence in ensuring that

the most economical method is used to provide the

service at any given time. Members of a stock exchange

find counterparties for their clients with the help

of the normal trading procedures and use the clearing

facilities of their stock exchanges irrespective of

whether these procedures are economically efficient or

are still very much susceptible to improvement. As a

rule the individual firm cannot overcome the rationalizing

effect of clearing-houses and the time-saving in

finding counterparties through centralization of

data about potential contracting parties. It must

be ascertained whether competition between

associations of dealers or investors offering

different dealing systems can help the most rational

system to become established where competition

between individual firms is unable to ensure

procedural efficiency, or whether such competition,

on account of its fragmenting effect, ought to be

regarded as a step backwards and progress in

procedural efficiency ought to be sought in a

different way. Financial services of the third type are those

provided by individual organizations because they

are obliged to do so under the terms of agreements

or by official provisions or regulations and for

which such organizations do not charge a fee. The

principal services of this kind are the production

of periodical reports and the provision of other

services in connexion with the servicing of securities

by issuers. Other examples are the safeguarding of

dealer firms against insolvency by means of official

requirements as to the amount of capital they must

have, to the extent that such requirements go beyond

what a prudent businessman would regard as necessary,

and the protection of investors through regulations

that stipulate that certain clients should only be

offered securities with a prescribed maximum risk

content. The self-interest of those compelled to

provide services of this kind will ensure that the

cost will be kept as low as is possible within the

scope of the regulations. However, in the first place,

 it is the responsibility of the regulators

that their regulations aim for a high degree of

procedural efficiency. The fourth and last category of financial services

cannot be sold for a consideration and cannot be

provided by individual firms. Into this category fall

many services protecting the investor which are not

part of the services assigned to the second category.

Although for example the dealing systems of the various

national stock markets give the investor more or less

intensive protection against price manipulation,

there is usually scope for additional protective

measures.

 The question arises as to how the investor's

possible interest in these services can best be met

and whether the procedural efficiency of the secondary

market is increased if such services are offered.

As in the case of financial services of the third type,

 this question can only be answered on the basis of each case arising.

 the source by Dr.Hartmut Schmidt