Let us quickly define dealers.
Dealers are entities who buy and sell securities for their accounts. They may be firms or individuals and who may seek the help of brokers or other counterparts. A broker is like an intermediary who executes orders on the client’s behalf. Unlike a broker, a dealer is a principal in his account trades. Dealers play a significant role in the market because they make markets in securities. They also underwrite securities and offer investment services to clients and investors. Hence, they are market makers who provide the bid quotes and ask quotes that we encounter as we look up the security price in an over-the-counter market. Aside from that, they are beneficial to the market because they help with liquidity, making long-term growth more feasible. In Canada, dealers are similar to investment dealers. However, investment dealers fall into a different category in the US. If you say investment dealer in the US, you are referring to broker-dealers, and it is not the same thing as the term dealer alone.
Tell me more about dealers.
In the securities market, a dealer refers to an entity such as an individual or a firm that is readily available and willing to buy securities at its bid price for its account. It may also refer to an entity ready to sell securities from its account at the ask price. The aim is to profit from the spread between the bid price and ask price and add liquidity to the market simultaneously. Unlike brokers, dealers do not earn money from clients. They also do not act as an intermediary between the buyer and the seller. Unlike traders, dealers do not buy or sell securities for their accounts for business purposes. Dealers buy and sell securities as part of their business.
Let us say that Mr. A facilitates trades between buyers and sellers. However, he does not buy and hold securities in his account. Does that make him a dealer? The answer is no. Nowadays, many factors affect the profitability of dealers. For instance, we have modern and techy requirements that match the dynamic market. We also have industry consolidation, a stricter regulatory environment, and the like. These factors raise compliance costs.
Dealer regulation
Brokers and dealers need to register with the SEC, and they must be FINRA (Financial industry regulatory authority) members. A dealer runs a matched book that contains repurchased agreements. He issues securities that he buys and sells. Sometimes, they also come from him. Finally, he is willing to buy and sell securities continuously. He makes a market in a specific security. If a person does all of these activities, he must register as a dealer with the SEC.
What sets dealers apart from brokers?
This may not be very clear to those who are new to this field. Brokers and dealers both buy and sell securities. However, these are entirely different people when it comes to their role in trading and investments. First, a broker does not place trades for himself but the client’s portfolio instead. He manages transactions between the buyer and the seller. However, many brokers are also dealers. Hence, we call them dealer-brokers. Some firms act as both depending on many factors such as market conditions the security involved. A dealer may charge for his services and place markup on his inventory since he is the principal in the account while the broker charges commission.
