The dual-capacity system is a framework for trading on a stock exchange in which the roles of stockbroker and stockjobber (market maker) are distinctly separated and performed by different firms. This separation contrasts with the single-capacity system, where firms, known as market makers, combine these two functions. This structure was a hallmark of the London Stock Exchange until the notable change marked by the Big Bang on October 27, 1986.
Historical Context
Pre-1986 Era
Before 1986, the London Stock Exchange operated under a dual-capacity system. In this system:
- Stockbrokers: Acted as agents for clients, buying and selling securities on their behalf.
- Stockjobbers (Market Makers): Provided liquidity to the market by standing ready to buy and sell securities from their own account, creating a smooth trading process.
The Big Bang of 1986
The financial revolution known as the Big Bang on October 27, 1986, introduced significant changes in the London Stock Exchange. The move to a single-capacity system allowed firms to act both as stockbrokers and market makers. This shift was driven by deregulation aimed at increasing competition and efficiency within the financial markets.
Key Events and Changes
- 1983: Announcement of the impending Big Bang deregulation.
- October 27, 1986: Implementation of the Big Bang reforms, introducing a single-capacity system and electronic trading.
Detailed Explanations
Structure of the Dual-Capacity System
In a dual-capacity system:
- Stockbroker’s Role: Execute trades for clients, earning a commission on transactions.
- Stockjobber’s Role: Quote buy and sell prices, maintaining a balance and ensuring market liquidity.
Advantages of Dual-Capacity System
- Specialization: Firms could focus on either dealing or brokerage, leading to greater expertise in each function.
- Conflict of Interest: Separation reduced potential conflicts, as brokers acted solely on clients’ behalf without holding a trading position.
Drawbacks of Dual-Capacity System
- Reduced Flexibility: Brokers had to rely on jobbers for prices, potentially slowing down transactions.
- Limited Competition: Specialization could lead to reduced competitive pricing and service innovation.
Diagrams and Models
graph TD
A[Stockbroker] --> B[Client Order]
B --> C[Stockjobber]
C --> D[Stock Exchange]
D --> E[Transaction Completion]
C -->|Provides Liquidity| D
A -->|Executes Order| C
Importance and Applicability
The dual-capacity system was crucial in establishing a structured and clear separation of trading roles, contributing to:
- Market Stability: Ensured there was always liquidity available.
- Transparency: Brokers and jobbers had clear, non-overlapping roles.
Examples and Considerations
Real-World Example
- London Stock Exchange: Operated under this system until the Big Bang reforms in 1986, ensuring efficient trade execution and market liquidity.
Considerations
- Market Evolution: The switch to a single-capacity system post-Big Bang reflected evolving market needs for more dynamic and integrated trading operations.
Related Terms and Comparisons
- Single-Capacity System: Combines brokerage and dealing roles, introduced post-1986 in London Stock Exchange.
- Market Maker: A firm that buys and sells securities from its own inventory to facilitate trading.
- Big Bang: The 1986 deregulation event that revolutionized the London Stock Exchange operations.
Interesting Facts and Inspirational Stories
- Big Bang Revolution: Marked a new era in finance, leading to the London Stock Exchange becoming one of the world’s leading financial markets.
- Inspirational Shift: Showcased how regulatory changes can transform market structures, encouraging innovation and growth.
Famous Quotes, Proverbs, and Clichés
- Quote: “Change is the end result of all true learning.” - Leo Buscaglia.
- Proverb: “Necessity is the mother of invention.”
Jargon and Slang
- [“Broker Dealer”](https://financedictionarypro.com/definitions/b/broker-dealer/ ““Broker Dealer””): Firm combining the roles of broker and dealer in a single-capacity system.
- [“Big Bang”](https://financedictionarypro.com/definitions/b/big-bang/ ““Big Bang””): The radical deregulation of the London Stock Exchange in 1986.
FAQs
What is a dual-capacity system?
Why was the dual-capacity system important?
What was the impact of the Big Bang on the dual-capacity system?
References
- The London Stock Exchange Historical Society.
- “The Big Bang of 1986”, Financial Times Archives.
- “Market Makers and Their Role,” Journal of Financial Markets.
Final Summary
The dual-capacity system of trading in stock exchanges represented a specialized approach where stockbrokers and stockjobbers had distinct and separate roles. This system was crucial for maintaining transparency and liquidity in the market until the regulatory overhaul of the Big Bang in 1986, which introduced a more integrated single-capacity trading environment. Understanding the evolution from dual to single capacity offers valuable insights into financial market mechanisms and the impact of regulatory changes.
