Why Challenger Brokerages Should Embrace Radical Transparency
Alan Grujic, Founder and CEO, All of Us, shares with Business Chief why challenger brokerages should embrace radical transparency.
At the start of October, Charles Schwab, a broker with a nearly 50-year history, announced it was introducing fee-free trading. This legacy player was almost certainly responding to seismic market changes brought about by challenger brokers, namely Robinhood, who have long offered fee-free trading.
If transaction fees were the golden egg sustaining the brokerage industry, Robinhood was the farmer who killed it. Canny observers will note that it’s only a matter of time until the rest of the industry followed suit, with legacy players either reducing or eliminating the fees they charge per trade. It is, after all, hard to compete with free.
This leads to critically important questions: If the industry pivots to fee-free trading, how will brokerages make money? And, crucially, can brokerages make money without undermining the interests of their customers, many of whom have embraced the stock market for the first time in their lives?
From Mobiles to Markets
On its surface, no-fee trading sounds exciting, but the truth is these fees never needed to be charged in the first place.
Think of telco operators back in the 90s, who all tripped over themselves to offer free long-distance calling when in reality it didn't cost any more money to place a long-distance call vs a local call. Technical advancements made it impossible to charge long-distance, and once the first operator sought out the competitive advantage, they all followed. In a similar way, the time for extraneous fees in investing has ended. However the real financial boon to brokerage firms isn't just in trading fees, it's in the amount of money they earn on each individual customer, figures they've never been willing to share.
For much of their history, brokerages charged investors crushingly-high fees. Each buy or sell order came with a commission attached, which often cost as much as US$10. In addition, small “mom and pop” investors regularly paid annual maintenance fees, either as a percentage of their portfolio or as a flat sum. Collectively, these charges disproportionately diluted any potential profits, thereby deterring many low-net-worth individuals from investing in the stock market.
And like long distance calling, these fees were wholly unnecessary. Few knew that the cost to place a trade was negligible compared to the sum levied by the brokerages. And it wasn’t long until a new generation of startups figured this out and launched their own commission-free trading platforms.
This happened in 2013, with the launch of Robinhood. This platform, which boasts 6 million users, is today worth an estimated $7.6 billion. That figure will inevitably grow as the company expands. It’s currently in the early stages of a European expansion, with a UK launch expected later this year. Across the Atlantic, Freetrade offers a similar service. In April this year, the app-based broker raised £1 million (roughly $1.2 million) in 77 seconds via Crowdcube, a popular equity crowdfunding platform.
The enthusiasm for these platforms highlights two unassailable truths. Firstly, there’s a large appetite among retail investors for services that cheaply facilitate stock trading. Secondly, and even more to the point, many of the fees charged by legacy brokers were simply unjustifiable. Collectively, their entry into the market has had a disruptive effect, forcing legacy players to lower their commissions drastically, or cull them altogether.
A Brave New Market
So, how will brokers make money when they can no longer charge on a per-trade basis?
There are a few answers to that. The most obvious is that many challenger brokers act like ultra-low-cost airlines, where they make money from ancillary services rather than the core product itself. This “freemium” model is extremely popular. Freetrade, for example, batches trades together and executes them at 4PM daily. If you want your order to go through immediately to capitalize on a particular price in the market, you’ll need to pay roughly $1.25.
Likewise, Robinhood offers commission-free trading, but charges a fee for trades made on margin. Users with a minimum balance of $2,000 can borrow twice their capital to trade with. They’re charged a flat fee depending on the amount they borrow.
Other revenue streams, however, are less savory. In October 2018, it emerged that half of Robinhood’s revenue came from third parties wishing to influence the way it executes orders. This controversial practice is called “payment for order flow,” or POF, and was pioneered by the disgraced financier Bernie Madof.
Critics of POF argue that it incentivizes brokerages to execute orders with whatever market maker will make them the most money, rather than what is in the best interest of the client. Although it’s illegal in many jurisdictions (the UK banned it in 2012), it remains an accepted practice within the US financial services sector.
Of course, there’s always two sides to every story. Proponents of POF say it’s an essential component for monetizing fee-free trading. They state that without it, platforms like Robinhood simply wouldn’t exist. Payment for order flow, it’s argued, is the mechanism that stops us from reverting to the dark era of $10 commissions on trades.
Yet another way brokerages are making money is by lending out hard to borrow stocks, a practice called short selling. Short sellers borrow a stock, betting its price will fall. When they return the shares to the lender at the original price, they profit from the difference. Essentially -- brokerages don't share the money they make doing this with their customers, who own those holdings in the first place.
Transparency is Key
For what it’s worth, the SEC mandates that platforms using POF inform their customers on an annual basis, after a trade is executed, and via their terms of service (which, let’s be honest, few people bother to read anyway). But is that enough? No it’s not.
Brokerages need to provide the most honest, fair and transparent options available for investors today, ensuring that people know how their money is being put to use. As it stands, this industry is sorely lacking a purpose driven brand that puts the people’s interests over our own. When you peel back the curtain it reveals that investment firms and platforms make significant amounts of money on the individual - money that each investor could be earning more of on their own. The truth is that free trading isn’t really free. The individual investor might not be asked to pay fees, but trust me when I say the company is still making money off each and every trade, and this is misleading to the consumer.
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With an industry notorious for its bad actors, radical transparency can allow brokerages to develop their brand, and crucially, instill trust within their customers. It will allow investors to see whether their brokers truly have their best interests at heart, and whether they would be better placed moving their portfolio elsewhere.
Consumers today have a different value system for companies they engage with, and that extends to investments as well. New generations are digital and social-media natives, expecting to tap into the benefits of both in everything they do. Consumers also place a much higher premium on trust and transparency with brands, and never is this more evident than with those to whom they entrust their money.
It was Benjamin Franklin who once famously said: “An investment in knowledge pays the best interest.” Complete transparency is possible and should be required and embraced by investors.
Marketing matters: from IBM to Kyndryl
Prior to joining Kyndryl as Chief Marketing Officer, Maria had a 25-year career at IBM, most recently as the tech giant’s CMO where she oversaw all marketing professionals and activities across North America, Canada and Latin America. She has held senior global marketing positions in a variety of disciplines and business units across IBM, most notably strategic initiatives in Smarter Cities and Watson Customer Engagement, as well as leading teams in services, business analytics, and mobile and industry solutions. She is known for her work with teams to leverage data, analytics and cloud technologies to build deeper engagements with customers and partners.
With a passion for marketing, business and people, and a recognized expert in data-driven marketing and brand engagement, Maria talks to Business Chief about her new role, her leadership style and what success means to her.
You've recently moved from IBM to Kyndryl, joining as CMO. Tell us about this exciting new role?
I’m Chief Marketing Officer for Kyndryl, the independent company that will be created following the separation from IBM of its Managed Infrastructure Services business, expected to occur by the end of 2021. My role is to plan, develop, and execute Kyndryl's marketing and advertising initiatives. This includes building a company culture and brand identity on which we base our marketing and advertising strategy.
We have an amazing opportunity ahead at Kyndryl to create a company brand that will stand apart in the market by leading with our people first. Once we are an independent company, each Kyndryl employee will advance the vital systems that power human progress. Our people are devoted, restless, empathetic, and anticipatory – key qualities needed as we build on existing customer relationships and cultivate new ones. Our people are at the heart of this business and I am deeply hopeful and excited for our future.
What experiences have helped prepare you for this new opportunity?
I’ve had a very rich and diverse career history at IBM that has lasted 25+ years. I started out in sales but landed explored opportunities at IBM in different roles, business units, geographies, and functions. Marketing and business are my passions and I landed on Marketing because it allowed me to utilize both my left and right brain, bringing together art and science. In college, I was no tonly a business major, but an art major. I love marketing because I can leverage my extensive knowledge of business, while also being able to think openly and creatively.
The opportunities I was given during my time at IBM and my natural curiosity have led me to the path I’m on now and there’s no better next career step than a once-in-a-lifetime-opportunity to help launch a company. The core of my role at Kyndryl is to create a culture centered on our people and growing up in my career at IBM has allowed me to see first-hand how to prioritize people and ensure they are at the heart of progress in everything Kyndryl will do.
How would you describe your leadership style?
I believe that people aren't your greatest assets, they are your only assets. My platform and background for leadership has always been grounded in authenticity to who I am and centered on diversity and inclusion. I immigrated to the US from Chile when I was 10 years old and so I know the power and beauty that comes from leaning into what makes you different from other people, and that's what I want every person in my marketing organization to feel – the value in bringing their most authentic self to work every day. The way our employees feel when they show up for themselves authentically is how they will also show up for our customers, and strong relationships drive growth.
I think this is especially true in light of a world forever changed by the pandemic. Living through such an unprecedented time has reinforced that we are all humans. We can't lead or care for one another without empathy and I think leaders everywhere have been reminded of this.
What’s the best leadership advice you’ve received?
When I was growing up as an immigrant in North Carolina, I often wanted to be just like everyone else. But my mother always told me: Be unique, be memorable – you have an authentic view and experience of the world that no one else will ever have, so don't try to be anyone else but you.
What does success look like to you?
I think the concept of success is multi-faceted. From a career perspective, being in a job where you're respected and appreciated, and where you can see how your contributions are providing value by motivating your teams to be better – that's success! From a personal perspective, there is no greater accomplishment than investing in the next generation. I love mentoring younger professionals – they are the future. I want my legacy as a leader to include providing value in work culture, but also in leaving a personal impact on the lives of professionals who will carry the workforce forward. Finding a position in life with a job and company that offers me a chance at all of that is what success looks like to me.
What advice would you give to your younger self just starting out in the industry?
I've always been a naturally curious person and it's easy for me to over-commit to projects that pique my interest. I've learned over years of practice how to manage that, so to my younger self I’d say… prioritize the things that are most important, and then become amazing at those things.