What Is Interpositioning in Finance?
Learn about interpositioning in finance: how a third party becomes central to facilitating transactions between two others.
Understanding Interpositioning
Interpositioning in finance refers to a practice where a third-party entity places itself between two other parties in a financial transaction. This intermediary acts as a principal in two separate, but closely related, transactions. Instead of facilitating a direct exchange, the intermediary first engages with one party, acquiring the asset or security, and then immediately engages with the second party, selling the same asset or security.
The intermediary takes on the ownership, even if momentary, of the financial instrument. This contrasts with an agency role, where a broker merely connects a buyer and a seller without taking ownership of the asset. The intermediary assumes both the risks and rewards associated with the temporary ownership of the financial instrument. This includes price fluctuations between the two legs of the transaction, even if the time difference is minimal.
Regulatory frameworks, such as those enforced by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), generally require transparency when a firm acts as a principal rather than an agent in a transaction. This ensures that clients are aware of the capacity in which their financial professional is operating.
How Interpositioning Works
Interpositioning involves a specific sequence of events. Initially, the intermediary, often a broker-dealer, purchases a financial instrument from a seller. This first transaction establishes the intermediary as the temporary owner of the asset. The purchase price in this first leg is agreed upon between the seller and the intermediary.
Immediately following this acquisition, the intermediary then sells the same financial instrument to a buyer. This second transaction completes the interpositioning process, transferring the asset from the intermediary to the ultimate buyer. The selling price in this second leg is agreed upon between the intermediary and the buyer, with the difference between the two prices representing the intermediary’s compensation or profit, often referred to as the “spread.”
For example, if a client wishes to sell shares and another client wishes to buy those same shares, a firm acting as an interposing principal would first buy the shares from the selling client. The firm would then simultaneously or nearly simultaneously sell those shares to the buying client. The settlement of these transactions typically adheres to standard market cycles, such as T+1 or T+2, meaning the actual exchange of cash and securities occurs one or two business days after the trade date.
Common Scenarios for Interpositioning
Interpositioning is common in several areas of the financial markets, often serving to facilitate transactions, provide liquidity, or manage risk. One frequent scenario involves market making, where firms stand ready to buy and sell specific securities. These market makers quote both a bid price (the price at which they will buy) and an ask price (the price at which they will sell), interposing themselves between buyers and sellers to ensure continuous trading. They earn revenue from the bid-ask spread, which is the difference between these two prices.
Another common application is found in over-the-counter (OTC) markets, particularly for less liquid securities or complex financial instruments not traded on centralized exchanges. In these markets, direct matching of buyers and sellers can be challenging. An intermediary steps in to purchase an asset from one party and then sells it to another, providing access to a market that might otherwise be illiquid.
Certain brokerage activities also involve interpositioning when a broker-dealer executes a client order by acting as a principal. For instance, if a client places an order to buy a security, the broker-dealer might fulfill that order from its own inventory or by immediately purchasing the security from another market participant and then selling it to the client. This approach can ensure prompt execution for clients, particularly for orders that might be difficult to fill directly in fragmented or thinly traded markets.