Digital brokers respond to EU watchdog’s call for scrutiny of zero-commission business models

On the 02/25/21 at 7:39AM


Tuba Raqshan

Targeted by ESMA's chair Steven Maijoor, zero-commission trading platforms decrypt their business models and stress that the public must have a greater say in public markets.
Steven Maijoor, Chair, ESMA

In a briefing to the European Parliament’s Committee on Economic and Monetary Affairs (ECON) on a potential Gamestop-like situation in the European Union, Steven Maijoor, chair of the European Securities and Markets Authority (ESMA) said that likelihood of such an event in the EU is limited but recommended a closer look at zero-commission trading.

Maijoor highlighted concerns of fee structure transparency and that specific aspects of online brokers’ business models may incentivise the adoption of risky short-term trading strategies. The chair of EU securities watchdog ESMA called for a further investigation of the role of online brokers’ busines models in creating the recent surge in retail investor participation. “We have observed the growing popularity of providers like RobinHood over the last 12 months, with the pandemic appearing to act as a catalyst for this increase in retail trading, against a backdrop of further digitalisation and falling trading commissions in finance,” he said.

While stating that lower costs for retail investors are a welcome development, Maijoor said that the phenomenon of zero-commission trading needs to be investigated. “Payments for order flow from third parties such as market makers may substitute commissions that are otherwise paid by clients, creating conflicts of interest, and resulting in less transparency for retail clients. In my view, the practice of payment for order flow needs to be carefully assessed against the MiFID II requirements on conflicts of interest, best execution, and inducements. Next to zero-commission trading, other practices also deserve scrutiny, such as the use of investment apps combined with a phenomenon known as the gamification of investing, potentially impacting retail investors’ risk awareness and contributing to the popularity of leveraged trading strategies,” stressed the ESMA chair.

eToro, a social trading and multi-asset brokerage, and Trade Republic, a German neo-broker who recently forayed into the French market, told Asset News that they welcomed the increased scrutiny by ESMA. eToro said that the public should have a greater say in public markets. “Is it without dangers or risks? No. Some assets are incredibly high risk now and we're urging our users to be cautious and to not simply invest in something just because it is going up,” stated a spokesperson from eToro.

Business models of digital trading platforms

Christian Hecker, co-founder of Trade Republic added that this increased supervision will lead to investor protection and will put a stop to certain players’ practices that undermine trust in the financial sector. Hecker told Asset News that Trade Republic’s operations will not be impacted, as it operates on a model that is different from the one offered by RobinHood. “Although Trade Republic offers a trading service accessible to all via a mobile app, it does not gamify investing and does not push customers toward leverage products or Contract for Difference (CFDs). Furthermore, Trade Republic developed an innovative trading infrastructure which allows customers to invest on financial markets without being charged the usual high commissions paid to other brokers, but rather a flat price of 1€ by transaction,” he said, explaining their business model.

Further distancing themselves from RobinHood, Hecker categorically stated, “Trade Republic does not sell any data to third parties to allow its customers to trade without commission. Trading takes place at reference market prices, e.g. from XETRA, there is therefore no conflict of interest and a respect of Mifid II regulation. The business model of Trade Republic is not comparable to the model of Robinhood,” he reiterated.

Preventing a GameStop repeat

To prevent an event like the GameStop rally in the US, Trade Republic has scaled its trading systems, according to Hecker. “Since Gamestop, we have greatly increased our server capacity and load testing. At the same time, we are investing massively in our technical infrastructure to improve our offering further. This will allow us to cope with surge of interest from our customers for any particular stock we offer,” he added.

The acceleration of digital technologies and low or zero interest rates have encouraged more retail investors to trade on these platforms. Elaborating on its business model, eToro pointed out that it has significantly reduced the cost of stock investing and is therefore able to offer stock investing to customers commission free (meaning that an additional commission is not charged over and above the underlying market spread – other ancillary fees will apply, however).

Sign in