What to Know about International Securities Exchanges - dummies

What to Know about International Securities Exchanges

By Consumer Dummies

Traditionally, a security is traded on an exchange, which is an organization set up to allow people to buy and sell. Exchanges grant trading privileges to different brokerage firms so that they can execute orders for their customers. If you plan to invest in emerging markets, you need to know at least a little about the particular market’s security exchange.

The alternative to exchange trading is over-the-counter trading, in which networks of buyers and sellers find one another in order to get trades done. Over-the-counter trading has exploded as information technology has improved. Many over-the-counter networks have requirements for participating members in order to ensure that no one is ripped off, so the lines between the exchanges and the networks have blurred.

You don’t necessarily need to have a brokerage account in the country where you trade, by the way. Many major brokers in developed markets have exchange membership or trading privileges all over the world. If they don’t have their own seat on an exchange, they may be able to do it through a partnership with another firm, an arrangement known in the trade as a correspondent broker.

The following sections describe the regulation of exchanges in emerging markets, dual-listed securities, and the accuracy of price quotes.

How to figure out who’s regulating whom

Securities exchanges are often for-profit businesses that need to generate a return for shareholders while fending off competition. That’s fine, but they also perform an important function in keeping capital flowing in a country so that businesses can expand. In order to ensure that they function, they are regulated. Stock exchanges have two types of regulation:

  • From the national government: The government almost definitely has basic rules for how the exchange should operate. The regulatory body may be the central bank or a dedicated regulatory agency. It sets and enforces rules on how much information companies need to give to investors, how quickly trades are settled, whether margin and short selling are permitted, and what qualifications brokers have to meet. Some exchanges are more closely regulated than others, but all have at least some government oversight.

  • From the exchange’s internal regulation process: Each exchange has rules for the standards that companies have to meet in order to be listed, for trading hours and procedures, and for obtaining permission to work as a broker or trader on the exchange. If you’re investing in a country where the laws are weak, the exchange’s governance structure should be more important to you.

Trading on material nonpublic information, also known as insider trading, is legal in some countries. In other places, it’s illegal or prohibited by the exchanges, but the rules against it aren’t enforced. It’s clearly illegal in the United States, but understand that in other markets, you may well be buying or selling against people who have more information than you do, and that makes it especially dangerous to trade against the price trend.

Dealing with dual listings

Often, securities are listed on more than one exchange. For example, a Chinese company may list its shares in Hong Kong, Shanghai, and New York. The only difference between the shares is the exchange rate, because the shares trade in local currency on the markets where they’re listed.

Because dual-listed securities have to meet the exchange-listing requirements on every exchange, investors often prefer them to other emerging market securities. After all, the more listing requirements a company has to meet, the more information about it is in the market that investors can use. And all else being equal, dual-listed securities tend to trade at a premium to other securities because of this.

Getting accurate price quotes

The academics like to say that all the information about a security is included in its price. If it’s cheap, it’s cheap for a reason, they say, because as long as people are free to buy and sell in a market with perfect information, prices will change to reflect changes in news. In actively traded markets, especially those in developed economies, prices more or less work as the academics say, mostly going up when the news is good and down when the news is bad. In emerging and frontier markets, though, prices may not reflect all the information about a company’s prospects. For that matter, the prices you see before you place orders may have nothing to do with the prices you receive when your orders are executed. The markets may not have the trading activity needed to force prices to respond to information, or there may be limits on the types of information that different people receive.

Here are two ways to evaluate the quality of the prices in a market:

  • Check the website of the country’s stock exchange to see how often its prices are updated. Do they change minute by minute, day by day, or week by week? The less often a trade takes place, the less accurate the prices are.

  • Look for the size of the spread between the bid and the ask. The spread is the difference between the bid and the ask. The wider the difference between these two numbers, the less often the stock trades — and the less accurate the price quote is likely to be.