I decided to pause my 3Rs series to review one particular event of this past week. No, not the political spectrum (guilty pleas/verdicts in the US and a new PM in Australia) but the bloodbath incurred in the discount broker space following JP Morgan’s announcement of the commencement of a free trade platform. In the event you missed it, the Tuesday morning market shudder (per Seeking Alpha) was:
Online brokers slump in premarket trading after JPMorgan (NYSE:JPM) says it’s introducing a mobile investing app bundled with free or discounted trades.
JPMorgan +0.7% in premarket trading.
Free, although a powerful word, generally comes with a cost that is perhaps hidden from view. JPM’s “You Invest” concept appears to primarily target Robinhood due to the success and demographics cultivated. Other brokers (highlighted above) appear to be collateral damage. The “pizazz” is that the 47 million JPM banking app users will have immediate access on roll out. The catches appear to be the “free” is limited to 100 trades the first year unless $15,000 is on account at the bank. To obtain unlimited “free-ness” requires $100,000 on account. So digging deeper than the headlines reveals the real cost of “free” although the $2.95 over-limit per trade certainly contains some value.
So the real question becomes, how profitable is “free”? Seeing the obvious – Client acquisition. JPM should have an edge with cross-selling to their embedded base. The only others that could come close to this advantage would be TD Ameritrade since they are about 45% owned by TD bank, Merrill (BAC), WellsTrade (WFC) and RBC Direct (RY). Potentially valuable but currently speculative particularly in light of Wells’ cross-selling scandals.
Next we see AUM management. Even if fee-less, the interest rate spread could be notable income particularly for a bank.
Next is the clearing function. Basically what ensures your trade settles as you the client expected. There are several clearing firms of which JPM is one. Apex is one of the larger of which a number of fintech firms use including M1, Acorns, Ally, and Betterment. Motif uses Pershing (BK) while Emperor uses Folio. The bigger brokers are self clearing. Point being, clearing function fees are retained in house if you are a clearing or self-clearing firm and a potential profit center when brokered.
Then there are fees for services such as margin trading, borrowing shares, options, etc. Regardless of the price point – the larger you are the more pennies you capture.
Finally there are the fees for order flow. Greater volumes result in higher profits (though sometimes to the detriment of the Main Street investor).
One report I saw stated trading fees accounted for roughly 8% of revenue on average with AMTD being the outlier. Frankly, I wouldn’t be surprised if this wasn’t the precursor to further industry consolidation – probably starting with the fintechs as size and volumes will begin to take on a greater importance towards profitability. So is the idea of free crazy? Perhaps. Just maybe – crazy like a fox.
Which leads me to possible actionable ideas:
- Minimize fractional shares in fintech accounts (M1, Motif). In all likelihood, if consolidation were to occur only full shares could be transferred resulting in forced sale of fractionals (taxable event)
- Determine if any of the clearing firms are buying opportunities (JPM, BAC, GS, BK, RY, SF and HTH). Also include BR as Apex contracts some of their services.
- Review the TD/AMTD relationship to determine if further exposure is warranted.
Disclosure: Long – TD,AMTD,JPM,BAC,GS,BK,RY,BR,WFC
As always your thoughts are welcome and we’ll return to the series in a couple of weeks.
Update 22 September 2018: John Dizard writes in the Financial Times that:
On September 14, … in Nebraska a case called Klein v. TD Ameritrade. The court found that instead of requiring each single brokerage customer to prove harm from payment for order flow under the rule covering securities fraud, the losses from the entire class could be determined by “the same algorithm the defendant (TD Ameritrade) uses to round orders in the first place”.
If the court does determine that the customer class has been harmed, TD Ameritrade (and maybe other brokers accepting payment for order flow) could have to disgorge years of revenues from the practice, and, possibly, other penalties and charges.
If that happens, and the Klein v TD Ameritrade district court rulings are affirmed on appeal, it will be an existential blow to the current model for much of the retail brokerage industry in America.