What Is an Agency Broker?
An agency broker is a broker that has a formal responsibility to act in the best interest of its clients. Unlike a broker-dealer or market maker, agency brokers do not hold inventory of the securities they buy and sell. Instead, they simply execute transactions on behalf of their clients.
- An agency broker is a broker that acts directly on behalf of their clients.
- Unlike a broker dealer, agency brokers do not hold inventory in the securities they buy and sell.
- Agency brokers are typically used by large customers; their relatively high fees make them uneconomical for most retail investors.
Understanding Agency Brokers
Agency brokers act as an intermediary between their clients and the exchanges through which they trade. Their responsibility is to act on behalf of their clients in securing the best possible terms for their trades. By contrast, broker-dealers buy and sell securities to and from their clients in order to generate profit for themselves. Because of this crucial distinction, it is important to understand whether a particular broker is acting in an agency capacity or as a dealer.
Agency brokers are typically relied upon by larger clients, such as investment funds, corporate finance departments, family offices, and high net-worth individuals. These clients have unique needs which differ from regular investors. For instance, purchasing large blocks of shares often requires more expertise in the execution of the trades, in order to avoid inadvertently affecting the price of the shares before the position has been established. Similarly, large clients may have unique tax considerations that affect the timing or execution of their transactions.
Agency brokers can also help large clients by providing some degree of anonymity behind their purchases and sales. For example, if a large investment firm begins purchasing shares in a particular company, the news of that purchase might trigger more public interest in the stock. This new enthusiasm could potentially drive up the share price and cause the investment firm's share purchases to become more expensive. For this reason, the firm might prefer executing their purchases through one or more agency brokers so that the purchase is less readily visible to other firms.
Although agency brokers can clearly offer important benefits to their clients, their expertise does come at a cost. Like doctors and lawyers, agency brokers require years of training and experience to develop their specialized skills. Unsurprisingly, their fees are correspondingly high. For most investors, agency brokers are likely to be an uneconomical option due to their relatively high cost.
Real World Example of an Agency Broker
Charlie is the manager of a large corporation that regularly invests in publicly traded stock. One of the companies he has been analyzing is XYZ Industrial, a manufacturing company that Charlie has long admired.
Recently, XYZ has fallen prey to a news scandal that has significantly depressed their stock price. In light of this, Charlie feels that the company's shares are now undervalued by the market. An avid value investor, Charlie decides to capitalize on this opportunity by purchasing a large block of XYZ's shares.
In doing so, Charlie contacts his agency broker and asks them to purchase the shares as efficiently as possible. What this means in practice is that the agency broker must carefully time the share purchases so that they can obtain the lowest possible price on behalf of their client.
If the broker were to place the entire trade in a short period of time, this would likely cause the share price to rise, causing the remainder of the share purchases to become more expensive. If on the other hand the agency broker waits too long before completing the purchase, the opportunity to buy XYZ at a relatively low price may cease to exist. Because of their expertise in navigating these complexities, Charlie is content to pay the agency broker's fees.