Administering fractional shares

I have a question for how this works legally.

So shares bought by clients are held by a different holdings entity in the clients’ names if I understand correctly thus far.

How is this going to be different, since these are going to be held in Freetrade’s name. How’s the legal structure for these? If you buy a fractional share, do you enter a synthetic contract with Freetrade as a counter party to it?

In the case of insolvency, are these considered Freetrade’s assets, and thus are liquifiable to settle Freetrade’s creditors?

Hi Fotis, the carved up share will be held in the nominee name and therefore as client assets. So you will not have a synthetic contract against Freetrade (in contrast - this is what you end up when CFDs are used to replicate fractions). In the case of insolvency, customers’ whole shares and fractions would be within the client asset pool and separate from Freetrade’s own assets.

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What is the liquidity profile of fractions?

I assume Freetrade is counterholding the rest of the fraction of a share I have bought, or they have sold it to another client. Since the markets are only operating on whole units, if I want to liquidate my fraction, do I have to wait for freetrade to liquidate with me, or another client to sell his fraction along with me, or can I just sell no problem?

And in that case, who am I selling to? Is it back to freetrade to make the fractional unit a whole unit, and if yes, isn’t that essentially freetrade acting as a counterparty?

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I would assume you would sell the fraction back to freetrade? and they would maintain one fractional share made up of the leftover parts of any fractionals held by customers?

We’ll have more on this closer to launch, but yes Freetrade will ultimately own the part of a share not owned by our customers, so we will be the effective counterparty for the fraction in some cases (but not for the whole shares). More details of how this works will be shared later.

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I sure hope not, because this means that for liquidating your position, you’re essentially hoping that freetrade can and wants to liquidate at the same time as you, or that it can provide you with liquidity.

No, they don’t need to sell their fraction, they buy your fraction

Here’s how I understand it. if two clients have 1/10 of a share each, Freetrade will hold the remaining 8/10. when one client sells freetrade buys the 1/10 and now holds 9/10.

Freetrade would only liquidate their fraction and sell the whole share back to the market when all the clients have sold and they no longer need to maintain it

This is my interpretation of how I think it works, I might not be 100% correct

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Hmm, will there be a toggle for this in the order screen at least? If I top up with, say £50, will it be possible to say to the app “Buy as many whole units as possible within that amount, but no fractionals?” if as a client I don’t want to expose myself to counter party risks as mentioned? Or will it be the default?

To clarify, the counterparty risk will be the same as with whole shares, as both fractions and whole shares will be held as client assets.

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That doesn’t answer my question. I’m not talking about custodian risk.

I’m talking about liquidity risk. My understanding thus far is that if I hold 50% of a share costing £1000 for example, then if I want to sell my fractional share, then this means that you have to buy it from me for £500. Correct me if I’m wrong please.

What happens if for example, in unfavourable market conditions, I want to sell but you are unable to meet the obligation of buying from me (insolvent)? And is it really an obligation for you? If I want to sell my fractional share back to you, is it possible that you can deny it? What happens if a liquidation order for a position contains fractionals. If I decide to sell 17.5 shares that I have in an expensive stock, for example, and you are unable to buy the fractional unit, will the whole sell position be unfulfilled or will it be partially fulfilled?

Another question is, is there any opt out of it? This introduces significant counter party risk. Can I inside the application turn this off somehow? Or at the order screen, have a toggle for only whole units instead of fractionals?

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I suspect that’s the reason for increased reserve requirements, Freetrade would need to be able to maintain a position of up to one share in every share on the platform

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Tasty discussion.
Might want to clarify that there will be an update to the contractual agreement (e.g T&Cs) between Freetrade (including nominee which I’m hoping will be named “Treefade Nominees”) and client with regards to administering the assets, beneficial Vs legal ownership and insolvency, would hopefully partially answer most of @Fotis concerns.

I won’t throw in commingling assets into discussion as you would have already discussed this as part of the business plan with FCA, although I used to love the “which depot” questions at work. But thinking about the behind the scenes changes with regards to trade flows, settlement cycles, reconciliations, etc it’s quite a task to get the structure and capacity in place :clap:
Good luck

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Say if I buy a percent of a share over a course of time, when I get to 100% will I have 1 share or lots of smaller percentages of different shares?

A post was merged into an existing topic: Fractions for all :pizza:

Sorry if i misunderstood, I was addressing the counterparty risk - i.e. the risk of our default / insolvency.

You are right that there are some differences in liquidity dynamics. If we were to become insolvent, one share would need to be sold and the proceeds distributed pro-rata to customers - so if you held 5.2 shares at that point, you would receive 5 shares back plus 20% of the proceeds from selling 1 share. There will be proper explanation and disclosures closer to launch, but to be clear, this will all be held in the nominee company as client assets.

Regarding liquidity when you send your order, we will share information on how this will work later, but we will not be under pressure because of market conditions on a stock. We will not be running inventory that we need to hedge, have short positions etc, nor are we trying to make money as a market maker. We will simply be facilitating the fractional investment by customers.

Finally, on choice between fractional and whole shares, the functional aspects are still be worked on so we’ll have more detail on this in due course

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This remind me of some software I wrote in a previous job quite a few years back, The customer was a Metal/materials stockholder. The thing about metal is you can cut it up and do stuff to it. so the system had to cope with them taking a 12" piece of steel out of the warehouse, chopping 3" off the end and selling it and a 9" piece going back in the warehouse.

The metal might have other stuff done to it such as galvanising so what you were selling was a different thing to what went out of the warehouse.

To make matters even more interesting/complicated/nightmarish there was another smaller company operating on the same premises. Company 2 could sell an item out of company 1’s warehouse and the system created purchase orders, work orders, invoices etc to sell the items from company 1 to company 2 automatically in the background, so all the above had to work as a distributed transaction across two companies servers.

It was interesting

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Is there a risk freetrade could lose money by having to part own shares?

e.g.
Amazon sp is $2,000
I buy $1,000
Freetrade needs to buy the other $1,000

Then Amazon sp drops to $1,000
I sell for $500
Freetrade then also needs to sell for $500?

Freetrade loses $500?

Even worse:
What if 1 customer buys $50 in Berkshire Hathaway? Does freetrade need to buy the remaining $323,000 worth of share?

I do not think that BRK.A will ever be offered on similar conditions to most other shares (same will probably go for Lindt and alike). But BRK.B will probably follow the scenario you have described :slight_smile:

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Yeah, but there’s also a chance they’ll gain a bit as well. Any loss in a a particular trade would only be on part of one share. If that becomes a serious issue we have bigger problems

Also Freetrade wouldn’t necessarily have to sell when you did, in fact they may not be able to if someone else has a fraction of the same share

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A post was merged into an existing topic: Fractions for all :pizza: