Reading a broker's financial statements

[Shadow Trader]

Publicly listed brokers and some regulated firms publish financial statements. Most traders never look. A few items reveal a lot about stability.

Capital adequacy: the firm's regulatory capital relative to requirements. A thin buffer suggests vulnerability to a shock like the 2015 Swiss franc event, which pushed several brokers into trouble.

Client money: the amount held, and whether it is segregated. Notes may describe where it's held and with which banks.

Revenue sources: how much comes from spread, commission, financing and, in some cases, trading gains against clients. A heavy reliance on client losses signals a B-book model.

Profitability and cash flow: consistent profits suggest sustainability, while repeated losses raise questions.

Legal proceedings and regulatory actions: notes often disclose investigations and fines.

Auditor's opinion: a clean opinion from a reputable firm adds some comfort.

Private brokers may not publish, which in itself is information. Comparing a few years of statements shows trends. Even a quick skim of the headline numbers separates well-capitalised firms from fragile ones.

One more thing to look for is related-party transactions and the structure of the group. A broker that sends client flow to an affiliated market-making arm has a different incentive structure from one that doesn't. The notes to the accounts sometimes explain it.

Have a broker's financial statements ever been read before funding, and did they change the decision?