Unveiling the Secrets Behind Neobroker's Success
In the dynamic world of online trading, neobrokers like Robinhood and Trade Republic have gained popularity among investors due to their low fees and user-friendly interfaces. However, these digital platforms are now facing scrutiny, particularly in Europe, as they grapple with potential conflicts arising from their business models.
Over the past 18 months, Germans have shown a renewed interest in investing and stock markets, driven in part by low-interest rate policies of central banks. This increased interest has not gone unnoticed by neobrokers, who have launched a service and product offensive to attract German investors.
However, the turmoil surrounding "meme stocks" has led to increased criticism of neobrokers' practices. A key concern revolves around the use of Payment-for-Order-Flow (PFOF) models, which account for over 80% of Robinhood's revenues and between €3 and €17.60 per customer order at Trade Republic.
PFOF, where brokers receive payments from market makers for routing client orders, may conflict with the Best-Execution requirements under MiFID II in Europe. This is because PFOF can incentivize brokers to route client orders to venues that pay the highest rebates rather than those offering the best trade execution quality. This could potentially prioritize the broker’s revenue over the client's best execution, raising concerns about impartiality and fair treatment.
The European Market Supervisor Esma considers the neobrokers' business model incompatible with the MIFID II legal framework in most cases. Key tensions include conflict of interest, transparency and disclosure, execution quality monitoring, and client protection.
The US Securities and Exchange Commission (SEC) and the European Securities and Markets Authority (ESMA) have initiated investigations against neobrokers, with regulators questioning whether PFOF arrangements compromise the obligation to ensure that client orders are executed on terms most favorable to the client.
Established brokers, while also benefiting from rebates, offer alternatives to routing and have more diversified revenue streams. A study by the Stiftung Warentest found no significant mark-ups compared to the Xetra trading of the German stock exchange, suggesting that traditional brokers may be meeting best-execution requirements more effectively.
However, the simple access to high-risk investments such as derivatives and cryptocurrencies by neobrokers is questionable due to the limited information about the risks and functions of these financial products. This could lead to regulatory restrictions for neobrokers, making them more susceptible than established brokers.
Robinhood, the US neobroker that revolutionized the industry with commission-free trading and intuitive user guidance via an app, opened 18 million accounts between 2016 and 2021 and went public with a valuation of around $29 billion. The company captured around 50% of all new account openings in the US.
As the regulatory landscape evolves, neobrokers will need to navigate these challenges to maintain their competitive edge while ensuring compliance with regulatory requirements and protecting their clients' interests.
[1] MiFID II Regulation (EU) 2017/563 of the European Parliament and of the Council of 15 March 2017 [2] ESMA guidelines on the MiFID II requirements on best execution, 12 April 2017
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