CHESS or custodian: making the right move with your broker
Fees, portability and voting rights are just some of the things to consider when choosing which model to use.
Choosing an online broker involves many considerations. Which exchanges and products can I access? Is there a one-off charge or an ongoing fee? Is there an app? Is it safe? The list goes on.
One debate that draws considerable attention online is whether (or not) to choose a broker with CHESS-sponsored ASX trades. Under this arrangement, the exchange has a record of you owning those shares directly, tracked via a unique identification number. Alternatively, some brokers operate a custodial model meaning they hold the shares on your behalf.
In one way it's good that investors are taking such care with their investments, seeking to understand not just what they're invested in but who their investments are with. But is this really an issue we need to be worrying so much about?
In this article we'll explore how both models operate, pros and cons of each, and give a verdict on whether it really matters.
What is CHESS sponsorship?
CHESS – or Clearing House Electronic Subregister System – is the system used by the ASX – or Australian Securities Exchange – to facilitate share trading on its platform. When you buy shares, CHESS will usually settle it within two business days, transfer the money between you and the seller, and transfer the legal ownership of those shares to you. CHESS also keeps track of the shares you own on its subregister.
To hold shares on the CHESS subregister, a sponsoring broker must issue you with an HIN – or Holder Identification Number – like an account number. This number is attached to your trades and holdings with that broker.
Major brokers who operate under this model include the big-four bank brokers as well as CMC Markets and SelfWealth.
What are non-CHESS-sponsored shares?
The alternative is to trade non-CHESS sponsored shares via a custodial broker. Under this model, the broker's custodian holds the shares on your behalf. You have rights to your assets and can withdraw them. This can be comingled with other investors or managed under an omnibus trust account structure. The third party keeps a log of who owns which shares. In a blog post, Stockspot CEO Chris Brycki explains that there was a move towards indirect ownership in the 2000s to "reduce trading costs, improve efficiency and increase profitability".
In Australia, IG Markets operates a custodial model. According to their website, shares purchased are held by Citi in a direct custody capacity. Australian shares bought through IG are registered in CHESS under Citicorp Nominees Pty Limited.
No, it's got nothing to do with the board game.
Pros of CHESS Sponsorship
Direct ownership – With the CHESS system you are registered with the ASX as the legal owner of the shares via your HIN number. Your broker operates as the facilitator between you and the exchange. This means that on the off chance your broker goes under, you won't be impacted as your shares are registered with the exchange, not the broker.
US-born Sharesight CEO Doug Morris acknowledges that this circumstance is rare but says it's not a hypothetical risk.
"If the broker fails, they pay out their largest credits first," he says. If you're a small retail investor, chances are you'll be forced to compete with others, or have to play by the custodians' rules for asset sales"
"This almost happened to me during the GFC. I was a small-fry investor with E*TRADE and because the markets were collapsing and people were liquidating their positions, I couldn't get access to my trading account. I called them and asked what's my recourse? They told me they'd get back to me – and reminded me that the shares were not held in my name. Thankfully they didn't go under, but many banks did."
Simplified portability – Competition for your dollars is fierce between brokers. If you decide to switch brokers to take advantage of a better price, or a more diverse product range, you can take your HIN number with you.
"By being CHESS sponsored, you're tied into the ASX's subregister where all other mainstream brokers are," says Morris. "What this means for the investor is that you can have your holdings transferred from broker to broker, even if they are competing brokers. This is almost an acknowledgement that they're in this for the investor – it's possible to switch with ease. These are your assets in this company, we are the execution platform."
Morris notes, however, that the HIN transfer contains limited information. The new broker will have recognition and access to your CHESS balance, but not your transaction or dividend history.
Voting rights – As an ordinary shareholder in a company, you have the right to vote at general meetings and make decisions on directors, remuneration and other company business. While every broker is different, some who operate a custody model don't pass voting rights onto shareholders. According to Saxo's website, voting rights are not afforded to traders with custody accounts.
Pros of non-CHESS Sponsorship
Access to more products and asset classes – Because your assets are pooled with other accounts, they can be used to tap overseas assets such as global fixed interest. Custody models also support fractional investing – where you can buy and sell securities in fractional amounts.
Competitive brokerage – Pooled holdings can mean lower trading costs for brokers which may be passed onto the end users. "Under a direct ownership model (CHESS), your fees are basically trading fees and not much else," Morris says. "With the custody model, they can offer more competitive fees or very low trading costs.
"However, you need to watch out for asset-based fees or cash account fees, or what exchange rate you're getting. If everything is co-mingled, the darker the box gets, and you have less transparency over what you're being charged for and why."
Does it matter?
Chances are if you hold shares on global exchanges, via an Australian broker, you're already trading under a custodial arrangement. CHESS is an ASX system operating inside Australia. If you want to invest in US shares, Australian brokers will go via a custodian – even SelfWealth.
When it comes to local shares, Andrew Campion, general manager, investment products with the ASX says it's up to the individual to do their research and make their own call on what they're comfortable with. He notes that the exchange supports both types of brokers.
"Yes, there is more legal certainty around having a HIN – having legal ownership not just beneficial - but it is very rare that a broker would go under," he says.
"There are examples yes. With collapsed stockbroker BBY, it did take quite a long time before people could finally get their funds unlocked. There's no free lunch. The brokers that use the HIN structure will probably be more expensive. It’s up to everyone to do their research and what level of risk they want to take on for the ownership ledger for their assets."
Morris agrees that it comes down to the individual. His preference lies with CHESS sponsored brokers.
"This issue tends to flare up when there's a problem, like with Robinhood and GameStop," he says.
"If you're just getting started as an investor and the custodial/omnibus model is how you can access the market because their fees are nil or very low, and their minimum trading requirements are low, then go for it."
"It's not about one being good or one being bad. If that's your only avenue for getting started, you should jump in.
"I personally prefer the CHESS model because I have direct ownership and I can control where I do my trading, where my cash is settled to and where my dividends are paid.
"I think as your portfolio grows and fees start to become more impactful, I think CHESS does make sense."
Remember that share ownership is only one factor in your decision-making process. You may also value things such as reporting and charting that are available via brokers which offer full-service investment platforms. Discover how to find the best online broker.