Chapter 1 · The Financial Services Sector

Three core functions:

1. The investment chain — connecting SAVERS with BORROWERS / firms needing capital
2. Risk management — insurance and derivatives, to TRANSFER and POOL risk (not eliminate it)
3. Payment systems — enabling transactions to happen efficiently and securely

Everything the sector does maps to one of these. Manufacturing, tax policy, and defence are NOT functions of financial services.

Financial services enable risk to be REDISTRIBUTED across those better able to bear it. Insurance pools many small exposures. Derivatives transfer specific risks (rate, FX, credit) between parties.

Applies to all market participants — corporates, governments, investors, households — not just to any one group.

Households, pension funds, and corporates with surplus cash need to invest it. Businesses, governments, and infrastructure projects need to raise capital. The investment chain is the set of intermediaries + markets + instruments that bridges the two.

Efficient allocation raises productivity and the competitiveness of markets globally. Regulation, transparency, and accessible instruments all reduce friction in the chain.

Primary market: where NEW securities are issued for the first time (IPO, bond issue, rights issue). The ISSUER receives the proceeds.

Secondary market: where existing securities are traded between investors. The issuer does NOT receive the proceeds.

Liquid secondary markets make the primary market work — investors will only buy at issuance if they can sell later.

• Retail clients — individuals investing their own money
• Professional / institutional — pension funds, insurers, asset managers, sovereign wealth funds, family offices
• Corporates — treasury operations, hedging, capital raising
• Governments — issue bonds, hold reserves
• Central banks — set monetary policy, manage FX reserves, lender of last resort

Sell-side: investment banks, brokers, market-makers — they SELL services (advice, market-making, capital markets access) to the buy-side.

Buy-side: asset managers, pension funds, hedge funds, insurers — they BUY services from the sell-side to invest their own or clients' capital.

Retail clients receive the HIGHEST level of regulatory protection — mandatory suitability tests, plain-English disclosures, cooling-off periods, ombudsman access. Professional clients (institutions) are treated as sophisticated and receive less protection because they have the expertise + resources to assess products themselves.

Commercial (retail) bank: takes deposits, makes loans, runs current accounts. Regulated for depositor protection + systemic stability.

Investment bank: advises corporates on M&A, raises capital (IPOs, bond issues), makes markets in securities, provides research, manages large trading books. Does NOT typically take retail deposits.

Many modern banks combine both (universal banks — JPMorgan, HSBC, Deutsche Bank). The US Glass-Steagall separation (1933–1999) legally split them; its repeal is often blamed for pre-2008 risk build-up.

• Advisory — M&A, restructuring, capital structure advice
• Underwriting — guaranteeing IPOs, bond issues
• Sales & trading — market-making in equities, bonds, FX, commodities, derivatives
• Research — publishing analyst reports for institutional clients
• Prime brokerage — servicing hedge fund clients (financing, custody, execution)

Broker: executes orders as agent on behalf of a client. Earns commission.

Market-maker / dealer: quotes both bid and offer prices in a security, trading as PRINCIPAL from its own book. Earns the bid-ask spread + inventory P&L.

Manage pooled investment funds (mutual funds, ETFs, pensions) or discretionary segregated mandates for large institutional clients. Compensated primarily via management fees (%AUM). Largest globally: BlackRock, Vanguard, State Street, Fidelity.

Aggregate contributions from employees / employers, invest for the long term to fund retirement. Two major types:

• DB (defined benefit) — promise a specific income at retirement; scheme carries investment + longevity risk
• DC (defined contribution) — define contributions in; retirement outcome depends on returns; member carries the risk

Massive pools globally — US, UK, Netherlands, Japan, Australia dominate.

State-owned investment vehicles that manage a country's surplus reserves. Largest: Norway (Government Pension Fund Global, ~$1.5tn+, funded by oil), China Investment Corporation, ADIA (UAE), GIC (Singapore), Saudi PIF.

Underwrite risk in exchange for premiums. Invest premium float in bonds + equities + real estate. Life insurers hold long-duration liabilities → matched with long-duration bonds. Non-life (property/casualty) hold shorter-duration liabilities.

Hold securities on behalf of investors + institutions. Handle settlement, corporate actions, income collection, tax reclaims, reporting. Largest globally: BNY Mellon, State Street, JP Morgan, Northern Trust.

Segregation of client assets from firm assets is central — a critical safeguard when the custodian itself fails.

The global FX (forex) market is the world's largest by turnover — the BIS Triennial Survey 2022 reports ~$7.5 trillion of trading per day. Traded 24 hours across global hubs (Sydney → Tokyo → London → New York → cycle). Largely OTC.

According to the 2022 BIS Triennial Survey, the USD appears on ONE SIDE of approximately 88% of all FX trades. Euro is second, followed by yen and sterling. Reflects USD's role as the primary global reserve + trade + commodity-pricing currency.

• Central banks — reserve management, occasional intervention
• Commercial / investment banks — dominant market makers
• Corporates — transactional hedging of trade / M&A
• Institutional investors — currency hedging of cross-border investments
• Hedge funds — macro / carry trade speculation
• Retail — small share (~5–10%)

Give retail investors a single account through which they can access many products — funds, ETFs, shares — and consolidate reporting. Examples: Hargreaves Lansdown (UK), AJ Bell (UK), Fidelity, Charles Schwab (US), Vanguard Investor.

Charge a platform fee (0.15–0.45% pa) on top of the underlying fund OCF. Popular UK tax-wrappers accessed via platforms: ISA, SIPP, GIA (General Investment Account).

New wave of low-cost, mobile-first brokers has reshaped retail distribution: Robinhood, Freetrade, Trading 212, eToro. Zero commission on many trades — revenue often via order-flow payments (banned in UK/EU, allowed in US), FX spreads, cash interest, premium subscriptions.