Tuesday, February 25, 2020 Stamford, CT USA - When the major brokers announced their move to commission-free trades last year, investors expressed concern that the shift may not prove as beneficial as advertised. Would brokers pack on additional fees or eliminate services to make up the difference in other areas? More importantly, would the move to commission-free trades degrade “execution quality,” and actually cost investors money?
“To understand why such concerns are likely unwarranted, and why investors are indeed much better off today, it is critical to understand brokerage industry history,” says Shane Swanson, Senior Analyst for Greenwich Associates Market Structure and Technology and author of The Impact of Zero Commissions on Retail Trading and Execution. “The same forces of regulation and competition that drove the industry to zero-commission trades remain in place, which means brokers must continue to ensure the highest levels of execution quality and service to stay in business.”
Price Improvement and Best Execution
Greenwich Associates research found that nearly 95% of retail trades are executed at the National Best Bid and Offer (NBBO), not surprising given brokers are required by law to secure “best execution” on client trades. At the same time, ferocious competition for trading business among traditional brokers, online brokers and the new “fintech” entrants that first introduced zero-commission trading leaves brokers little leeway to tinker with execution quality—even if they wanted to.
Equally fierce competition among market makers also works in favor of investors. These market makers fight for this order flow, and the resulting “price improvement” can be significant. In fact, public data shows that nearly all retail-size orders benefit from this price improvement, which in 2018 amounted to more than $1.3 billion in savings to retail investors. While it is impossible to know what the market might look like if these orders were all routed to the public market, such quantifiable savings via the current model are hard to ignore.
What’s Next for Retail Brokers?
Brokers have every incentive to maintain execution quality and to continue providing top-notch client service, research and other tools as trading commissions become a smaller part of overall revenue. “The fact that so many retail brokerage revenue streams operate on economies of scale suggests that, in a zero-commission world, consolidation is nearly inevitable,” says Shane Swanson.