Small investors on the stock exchange will be insured up to 20,000 euros

The process of compensating small investors on the stock exchange would be initiated when a brokerage firm could not meet its financial obligations to clients or could not return their securities. This refers to bankruptcy, fraud, or liquidation of the brokerage firm.

Written by: Lidija Kiseljak

By the end of the year, a draft law on the securities market should be completed, which will most likely be called the Capital Market Act, and it will be fully aligned with EU directives. The transformation of brokerage firms into investment companies, which will have to increase their capital base, but also, like any financial institution, take care of capital adequacy, as well as pay greater attention to non-professional investors, and small investors will be financially insured like depositors in banks, are some of the novelties that the new law will bring, most likely written in around 500 articles. The current Securities Market Act contains 165 articles. Along with the necessary definition of the novelties on which two working groups composed of industry representatives are working, Hanfa has already adopted several regulations that will be included in the new Capital Market Act, but which will also apply before the law comes into force, most likely in 2009.
 
Capital Adequacy Provision

Some brokerage firms have already begun calculating costs as compliance with the EU will require allocating much more money than now. For example, the capital base will no longer be in the range of just 200,000 kuna to four million kuna, depending on the types of activities for which the brokerage firm is registered. The minimum capital of 200,000 kuna currently required for performing basic activities, i.e., trading in securities, often serves individuals to open a brokerage firm primarily for their own reasons, i.e., to conduct transactions on their own account without having to pay commissions as brokers. Due to such easy possibilities for opening a brokerage firm, market participants have long believed that the capital base should have been increased long ago.  

How much it will increase is still unknown, but it is certain that there will also be a range of values, depending on the types of activities for which the brokerage firm will be registered. Brokerage firms will henceforth be called investment companies and will be defined as financial institutions, so the capital adequacy provision and Basel II will also apply to them. – Therefore, an additional cost of the investment process will also be the allocation of money for riskier investments – says Daniel Nevidal, a member of the Management Board of Intercapital. Preliminary discussions among financial supervisors have indicated that the adequacy ratio will most likely be 10 percent, the same that applies to banks, i.e., future credit institutions. These future investment companies will also be able to perform custodial services, which can currently only be performed by banks.

Costs of several million kuna

Depending on previous investments in the brokerage firm, the cost incurred during compliance with the future law will also depend. However, those who will want to establish a brokerage firm will no longer be able to do so with little money because, according to the announcements of the President of the Management Board of Hanfa, Ante Samodol, they will have to comply with all Union requirements even before entering the EU. For investment companies in the EU, the adjustment cost was around 20 million euros, so Samodol has already announced that the adjustment cost for domestic firms could be around two million euros. The brokerage firm ICF has begun calculating costs, and according to its director Ratko Bajakić, it amounts to two to three million kuna.
– First of all, this includes the cost that will need to be allocated for personnel and the IT sector. For example, accounting in the investment company will no longer be allowed to be outsourced.

– IT support must be at a top level with all built-in protections and clear delineation of which information some employees of the company can access – says Nevidal. Along with the cost that will arise from compliance with EU directives, domestic brokerage firms will also feel a second blow due to foreign competition. Namely, upon entering the EU, foreign brokerage firms will be able to open their branches in our country. Foreign investors will no longer have to use the services of domestic brokerage firms, which will reduce their business volume. Due to both cost and competition, domestic brokerage firms will certainly follow the fate that befell the banking market a few years ago. Many brokerage firms will likely close down, some will merge, or they will be taken over by stronger ones. – Consolidation is taking place worldwide, so it will not bypass us – says Nevidal. For some, competition will certainly be too strong, especially for firms that have not found their niche.

Change in organization

A particular issue of compliance will be focused on the organization of work within the brokerage firm.
– This refers to the establishment of departments and hiring people for compliance with all laws and regulations that affect business and their adherence (compliance) – says Nevidal and adds: – It will be necessary to establish special internal control and special management for risk management. This means that a standardly organized firm will have to have at least seven to eight employees, i.e., at least two brokers, management, back office, accounting, internal control, risk management, etc. Organizational issues, as well as a large part of other sections of the future law, have already been defined by a series of regulations adopted by Hanfa.   

Among them, for example, last week regulations on preventing conflicts of interest and the content and manner of maintaining the order book were adopted, as well as the previously adopted Regulation on preventing market manipulation. This week, Hanfa is adopting a regulation on the classification of clients that will apply from next year. Investors will thus be divided into retail investors and professionals, and the approach to them will be different. – Thus, the investment company will have to provide complete information to non-professional investors, i.e., design the service for such a client to be the most favorable for the investor – says Marin Hrešić, director of Erste Securities.

Investor protection

– Like depositors in banks, small investors on the stock exchange will be insured up to 20,000 euros. The same insured amount applies in the EU, so we will not change it – says Samodol. The same amount will also apply to deposit insurance in banks, i.e., around 160,000 kuna instead of the current up to 100,000 kuna. The process of compensating small investors on the stock exchange would be initiated in cases where a brokerage firm, for certain reasons, could not meet its financial obligations to clients or could not return their securities held on behalf of the client, and there is no possibility of such a situation changing in the short term. In other words, in the case of bankruptcy, fraud, or liquidation of the brokerage firm that cannot fulfill its obligations to investors due to this, investors would be compensated from the so-called investor protection scheme or the so-called compensation fund. The holder of this project is the Central Depository Agency. All members of the stock exchange would participate in filling the fund, and if an insured event occurred, investors would be compensated according to certain criteria.