Principal vs Agency Trades

CFA Level II Ethics
#1

Hello,

I don’t really get the difference between principal trades and agency trades, can someone explain that?

Let’s say I am a fund manager with several mutual funds and individual mandates under management. What kind of operation constitutes a principal trade / agency trade?

Thanks a lot for your help!

Anna

#2

Principal is trading for yourself or money for your firm

Agency is trading for a client, and you commission off the spread

#3

A principal trade is when you execute a trade for a client from the inventory held by your firm,

For an Agency trade, its done through a broker.

#4

Well put.

Dealers can also do principal trades as they are making a market (but also trying to earn money for themselves) using their own capital.

Agency trades always through a broker.

#5

Hello All,

Thank you for your replies. Now if I get well (correct me please):

  1. If I am a pure asset manager with no broker-dealer department, I can only do agency trades, since I always trade my clients’ security stocks through a broker. I don’t see how I could do principal trades.

  2. If I am a company with both asset management and broker-dealer activities, I can do both agency and principal trades. Agency trades would involve trading my clients’ securities through an outside broker (not my brokerage department), whereas principal trades would involve trading for my client with my own broker-dealer department AND this department’s security stock (like buying a stock for my client that is sold by the broker-dealer department of my company), right?

  3. If I am a pure broker-dealer company, principal trading would be selling a share to a client from my own security stock. I couldn’t do agency trading in this case, right?

Thank you again for your precious help!

Anna

#6

  1. No, agency trades are if you are a buy side firm, if you use a broker from JP Morgan, that is an agency trade

  2. I think so.

  3. Broker-dealers use their own capital to make markets and try to profit from that. So that is pricipal trading- you’re using your own principal.

#7

I was searching the internet for some clarification on this topic and Google brought me right back to Analyst Forum! Would the following be a fair (albeit simple) assessment of principal / agency basis?

Agency Trades involve a commission and are executed through a broker.

Principal Trades involve a spread and are filled through a firm’s inventory.

Thanks in advance for the input. Have a great weekend, everyone.

#8

The names say it all:

Agency trade : you’re acting as an agent for a client. You don’t take part in the trade (i.e., you don’t buy a security for yourself, and you don’t sell one of your securities), you merely facilitate it for your client.

Principal trade : you’re acting as a principal; you do take part in the trade. Either you buy a security for yourself, or you sell one of your securities.

(In the above, your and yourself are intended to refer to either you personally or your firm.)

#9

I assume this question was posed in relation to soft dollars whereby the Section 28(e) of the SEC Act states that soft dollars are legal only for agency trades and not for principal trades.

The question I have about this is, why is there even a question of soft dollars in principal trades? Why is there such a distinction? If you’re trading for yourself, a.) Why are you not allowed to do whatever you want? b.) why is it even illegal to pay higher amounts for your trades in return for research?