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This month I visited Laurence Marsh at Winterflood's offices in the City

Market Makers are somewhat of a mystery to most private investors. These companies seem to exercise a strong influence on the small companies market and yet we know little about them and how they operate. In this month’s Meet the Players article we unravel some of the mystery as our subject is Winterflood, the number one AIM Market Maker.

I paid a visit to Winterflood’s offices in the City where Research Analyst, Laurence Marsh, was most helpful in answering my long list of questions.

The Business

The Company was founded by Brian Winterflood in 1988. At this time Winterflood made a market in just 450 UK, mainly smallcap, stocks. Over the years the Company has broadened its coverage and today Winterflood makes a market in over 11,000 instruments, including all UK equities, European and North American stocks, funds, covered warrants, Exchange Traded products, gilts and bonds.

Winterflood is a wholly owned subsidiary of FTSE 250 banking and financial services group, Close Brothers. Indeed in the Close Brothers 2009 accounts Winterflood made a significant contribution to Close’s strong results. Winterflood’s excellent performance was driven by a rise in the average trades per day from 27,000 to 42,000.

I asked Laurence Marsh about the increase in trades and the recent buoyancy of the markets. He believes that the recovery has been primarily due to increased volumes from private investors. He says that many companies do not appreciate just how much influence retail investors have on the market, particularly in the small companies.

Winterflood are primarily market makers, although they do also have a small specialist corporate Investment Trust business. Laurence says that they are very experienced market makers and they strive to offer an excellent service to their clients.

Most of the market makers in London have been set up as an arm of a broking firm.  These market making businesses were set up initially to make a market in the shares of the broker’s client companies.

By the nature of their business Winterflood need to take positions in a wide range of stocks and other instruments. However, as they are primarily market makers they do not take long term investment positions in any stock or sector.

The Dealing Room

Winterflood employs approximately 200 staff of whom 90 are traders. The traders, who are mostly male and quite young (at least, they seemed quite young to this ‘mature’ investor), operate in a large dealing room. This dealing room is very impressive with each work station having a substantial bank of busy electronic screens.

The market makers work long hours. They arrive at their desks at 6:40am ready for the first wave of RNS news items at 7am and their day finishes around 4:50pm after the market has closed. Even breakfast and lunch are taken at their desks. Before breakfast and lunchtime, the trainees – still known as ‘blue buttons’ harking back to the days of the old London Stock Exchange – will take food orders for their more senior colleagues.

Whilst Winterflood has expanded to cover all main listing stocks it still retains a specialism in smallcaps. Approximately 40% of their traders are employed on the AIM and small companies section.

The AIM section is divided into seven ‘books’ with each book manned by two senior traders. Winterflood divide its books alphabetically rather than by sector. In this way each book has a spread of companies from different sectors.

I was shown into the dealing room and introduced to the traders on the AIM D to H team.

The dealers are responsible for monitoring their positions in each stock and for their net short/long position across their whole book.  Away from the dealing room, risk controllers are monitoring the positions of all books to ensure that the business as a whole is not taking on too much risk in any area.

On the day of my visit, the AIM D to H section was having a busy day. The market makers highlighted that there had been a particularly high level of activity in two oil and gas companies, Empyrean and Gulf Keystone following recent news. Indeed, Gulf Keystone had recorded over 250 trades before 11am on that day.

As I own shares in two very small AIM companies in the D to H range, I was keen to find out just how much the market maker knew about these businesses. I must say that I was impressed with their level of company knowledge. The market makers were also keen to stress that each share has its own trading characteristics which they come to understand with experience.

I asked how they determined the prices to set following a news item. This again is put down primarily to knowledge of the companies they cover and experience. The market makers react to the flow of trades and move prices accordingly. So, for example, where a price has been moving up on strong buying, the market maker will be ready to reverse the price trend once sellers appear on the scenes.

increased volumes from

private investors

each share has its

own trading characteristics

AIM Supporter

Winterflood has always been a strong supporter of the AIM market. When AIM first commenced in June 1995, the Company undertook to make a market in all AIM companies. The commitment to cover all AIM stocks continues today, although there is one US AIM-listed company not covered by Winterflood simply because there is effectively no UK trading in this particular stock.

There are many small companies where Winterflood is the only market maker. Laurence said that they would prefer to have at least one more market maker involved in these small companies as they thrive on competition.

Where there is only one or two market makers the bid/offer spread is often wide which is obviously not popular with investors. Laurence was keen to point out that Winterflood are simply facilitators in the market place. The price they quote is a factor of the supply and demand for those shares in the market.  Where shares are very lightly traded Winterflood must charge a high premium for the risk they undertake when taking a position in such shares. Conversely, where a share is actively traded the market maker can offer a very narrow spread.

commitment to cover

all AIM stocks

Winner

Approximately 90% of Winterflood’s trades are handled by their electronic ‘Winner’ system. This system operates in conjunction with the systems of the leading stock brokers.

When a private investor enters a trade request with a broker, the broker’s system automatically polls the systems of all of the market makers for that stock. The broker’s system then automatically selects the best price for its client and the trade is then routed through this market maker.

Often a market maker will offer a price ‘inside the spread’ to a broker and in doing this they are competing with fellow market makers for business. The quoted bid and offer price, also known as the ‘reference price’, is in effect the market maker’s shop window price.

The Future

Laurence Marsh is optimistic that the buoyant market conditions will continue in the New Year. He points to the way that many excellent new businesses have grown out of every recession to date and this one will not be an exception.

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Written by: Michael Crockett

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