When did it all go wrong? The answer might just be this week, 25 years ago. Thursday, 25 October is the anniversary of the Big Bang, the day on which the way we trade shares in the UK changed completely.
Before that, the market was divided into brokers and jobbers. The brokers spoke to investors, took orders from them and charged them commission on deals. They then went to the jobbers who provided the liquidity in the market and took a spread between their buying and selling price (the bid offer spread).
This didn’t make things cheap for investors, particularly as commissions were fixed – there was no such thing as shopping around. However, the system did have good points. As Fundsmith’s Terry Smith points out, investors were protected by the fact that the “broker’s relationship with the jobber was an adversarial one” – he worked to get the best price when dealing.
The problem with it was that the fixed commissions prevented competition and that the UK was losing influence as a financial centre as a direct result. So on 25 October 1986, fixed commissions were abolished and at the same time – to compensate the brokers who would inevitably end up with lower commissions on each trade – brokers were allowed to combine with jobbers to form “dual capacity firms”.
Smith was, he says, all for it at the time. Now however, he sees that it was a “colossal mistake.” Why? Because it introduced “insuperable conflicts of interest.”
Brokers were no longer the agents of the investors. “Instead, they were dealing with integrated firms which maximised profits by giving investors the worst deal they could as they were principals on the other side of every transaction.
“And these were not the only conflicts of interest which arose from the Big Bang. Integrated securities businesses also provided merger & acquisition advice to companies – formerly the domain of merchant banks – as well as providing research on those companies’ shares for investors in those shares, trading in those shares as principals and raising equity or lending money to fund the deals. The potential for profit at the expense of investors as a result were manifold.”
I agree with Smith on most of this. But I’d say the Big Bang did one more thing that hasn’t really worked for us as well. It removed the expense and the friction of trading and in doing so helped (along with similar reforms in the US and elsewhere) to remove one of the cornerstones of successful capitalism from our markets – the responsibility of ownership.
If you can trade things easily and cheaply, you do. If you can’t, then you hold things for longer and work to make it worth your while to do so. That’s why institutional shareholders used to be long-term investors and why now they are almost always short-term investors.
Forty years ago, if you owned shares in a bank and weren’t too happy with the way the chief executive was leveraging up the balance sheet and paying himself £30m a year, you might have worried about the long-term viability of the business and gone in for a chat.
Five years ago, you would have just figured you’d have time to sell before the music stopped. That’s a very different thing. And herein lies, I think, the core of our current problem.
Capitalism needs long termism and it needs its participants to have a sense of responsibility to it. Right now our endless reforms – all designed to increase speed and liquidity – mean that they just don’t.