The normally placid world of stockbroking is being shaken up by the growing prominence of tech-savvy discount brokers. Last summer Dutch broker, DEGIRO, made a splash when it began offering the cheapest share dealing available in the UK. And in December, the London based discount broker iDealing became the first brokerage in Europe to offer free stock trading. The company launched a zero-commission service on the Belgian, Dutch and French Euronext markets, allowing investors to trade stocks, bonds, exchange traded funds (ETFs) and some derivatives listed in these markets, for absolutely nothing.
These innovations from online discount brokers are challenging traditional firms, pushing them to compete on commission fees. Of course, lower trading costs are generally good news for private investors and many of our readers have happily jumped onboard with the uber discount brokers. But is there a catch? How exactly are these brokers able to offer such low rates?
Going Dutch with DEGIRO
DEGIRO is a case in point. In June it launched in the UK offering trading commissions from as little as £1.75 plus 0.004 per cent per trade. The company was set up in 2008 in Amsterdam by five former colleagues, all of whom had worked at the Netherlands’ largest online discount broker, BinckBank. Since then, it has expanded into 18 European countries and amassed 90,000 clients across the continent.
Chief executive Gijs Nagel says the reason DEGIRO has grown so quickly is due to a lean business model and a relentless focus on technology.
He said: “We are a fintech [financial technology] company. We originate from a different way of thinking- efficiency and IT is everything.
“Most brokers managing the volume we have, would have 600 to 700 staff, we have 150 people; they would be active in one or two countries, we are active in 18 countries.”
From the beginning, the firm was focused on using technology to establish an edge in the broker market. In contrast to most small-medium sized brokerages which typically commission their platform technology from external IT companies or white label an existing platform, the company built its systems in-house. It was able to do this as three of the founders have a background in IT systems development.
In addition, DEGIRO chose to focus initially only on institutional investors believing they would, in Mr Nagel’s words, “bring in a lot of flow.” The sheer volume institutional investors trade in enables the firm to negotiate wholesale fee structures with each security exchange it connects to– currently about 100 exchanges worldwide.
However the company always had its eye on the private investor market and an ambition, it says, to end “the unfair, unnecessary gap between retail and institutional investors.” In 2013, it began extending its service to private investors across Europe giving them access to security exchanges at similar prices to its institutional clients.
DEGIRO says it can do this as the addition of numerous private investors executing lots of smaller trades places no extra burden on its infrastructure than its existing institutional investors. Currently these institutional investors are based in the Netherlands and number about 60 investment firms.
Clients are able trade shares as well as some bonds, derivatives and exchange traded funds (ETFs). DEGIRO also provides real-time quotes for free. However it doesn’t offer telephone broking, individual savings accounts (ISAs) or self invested pension programme (Sipp) accounts.
Free trading with iDealing
The theme of technology and a lean business approach also feature strongly in iDealing’s case. The London and Paris based firm is comparatively an old-hand in the world of online discount brokers, having been founded in 2000 by American-born, Lee Foster Bowman.
Mr Bowman previously worked as a derivatives trader for Deutsche Bank before setting up the company– which at the time was the cheapest online broker in the UK. He describes iDealing as being well ahead of the current trend of tech-savvy businesses challenging traditional financial services models.
He said: “We’ve written every single system that we’ve operated on. Most of our competitors don’t write any of their own systems; they buy it from other software houses or they use systems capabilities from third parties. And we automate every single process that could possibly be automated – we were fintech before fin tech.”
The company designed and operates its own platform, clearing and settlement systems with a small team of only 17 members of staff. It is this focus on efficiency and technology which Mr Bowman says led the firm to be able to launch a zero-commission service in December 2015. The news made iDealing one of a tiny number of brokerages in the world to offer zero-commission trading. The US based start-up Robinhood, which offers free trading on more than 5,000 US securities, is another notable firm.
In addition to keeping operating costs low, iDealing plans to make money from interest payments on spare client cash and charging administration fees for activities such as transferring out money and processing dividend payments and corporate actions.
“In order to be able to offer commission-free trading you’ve got to have very good in-house IT systems development, and a strong balance sheet. At the moment we are uniquely placed to offer this,” said Mr Bowman.
But is he concerned by some of the new species of online discount brokers, like DEGIRO, who are also offering low fees driven by similarly technology focused, lean businesses?
He is not perturbed: “Now, that we’re free who cares what discount rates are. You can’t go below zero. I don’t know who’s going to be able to undercut us because zero is the floor.”
He says large brokers would need to change their whole business model to be able to offer free trading while smaller companies typically don’t have the capacity to develop the necessary clearing and settlement systems in-house and from scratch. Although he acknowledges a potential challenge from new start-ups who could seek to emulate the firm’s model, he suggests such companies will need to be operating for at least five years before being able to offer commission-free trading.
The small print
Nevertheless it’s not all plain sailing. Despite the UK being its biggest market, iDealing admits it will take between one and five years before it is able to bring free trading to the UK, citing regulatory complexities. And with a brand-new model to demonstrate the jury is still out on whether the discount broker will be able to make zero-commission trading work in the long term.
Likewise, with DEGIRO there are other factors for would-be investors to consider. As a Dutch company, the broker operates in the UK via an EEA passport meaning that if the broker were to go bust compensation would be handled by its host country’s compensation scheme, not the UK’s Financial Services Compensation Scheme (FSCS). While registered with the UK’s Financial Conduct Authority (FCA), DEGIRO is regulated by the Dutch regulator. The Dutch scheme provides a maximum compensation of €20,000 compared to the FSCS’s £50,000.
Despite this, the huge uptake by customers across Europe of DEGIRO’s services suggests the company is proving its business model and challenging established brokers in the process. This is a prospect that pleases chief executive Gijs Nagel no end.
“The way I see it a lot of brokers– even some of the online brokers– are dinosaurs,” he said.
“I do not really compare myself to the broker world that’s out there now. It’s really outdated and built upon getting as much fees from clients in a short amount of time. We want to have clients for 30 years, not one year.”
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