Exploring the rise of commission-free trading apps

A new breed of trading apps are seeking to disrupt the status quo by offering users the ability to purchase shares and other securities without paying any commission fees. This has attracted a new younger demographic of investors who are price conscious and take an interest in their financial futures.

However, the sustainability of these services has not yet been fully tested. The range of investments offered by these services is still relatively limited, and established platforms have already started to introduce commission free trading. To stand a chance of prospering over the long term, they will need to continue to effectively market to this younger group, while diversifying to provide a full suite of wealth management services. 

Business Model

 Unlike traditional share trading platforms (such as Hargreaves Landsdown and AJ Bell), which tend to charge users around £10 for each transaction, commission free trading platforms do not charge any fees for the bulk of their trading activities.  

This new type of business is being spearheaded by the US based Robinhood, which launched in 2013. The demand for their service was so great that prior to their launch over one million people had signed up to use the platform. 

More recently in the UK, Freetrade launched a similar service, with Revolut adding fee free trading to their banking offering last summer. 

These platforms operate via a freemium model, with services tiered between free and premium paid for levels. Freetrade generates revenues by charging users £1 for instant trades (the free service only has bulk trading functionality with all requests taking place at 4.00pm) and £3 per month for ISA management. 

Correspondingly Robinhood Gold, which costs $5 per month, allows users to benefit from margin trading, meaning that they can access a credit facility to borrow funds to invest in stocks.  

The trading element of Revolut is an ancillary feature complementary to their core banking services. Revolut Metal (the highest priced subscription) users are unrestricted in the number of trades they can make, whilst premium and standard accounts are capped at three and eight trades respectively. Users are charged £1 for each trade which is not included within their subscription package. 

Attracting a millennial audience 

Commission free share trading has become particularly popular with millennials, who are increasingly becoming interested in personal finance. Given their propensity for price sensitivity, they are flocking towards commission free platforms. 

A recent US based survey revealed Robinhood (which finished above Fidelity and Vanguard) to be the most widely used investment service for this demographic. 

Key differentiators of these platforms, when compared to incumbents, for this group include not having to open an account with a minimum spend and a mobile first experience. While many incumbents do have app functionality, they do not provide the seamless experience expected by millennials. 

Additionally, another attraction is their ability to access fractional shares. This allows investors to purchase a proportion of a single share, which has a particularly high value, such as Tesla, Apple or Netflix. 

Are commission free platforms more than a passing fad? 

In the last few months incumbent brokers have started to introduce their own commission free service offerings to compete. In October Charles Schwab announced that they would be scrapping their commision fees. This was shortly followed by Fidelity and Vanguard.  

One of the core strengths commission free providers have had over legacy platforms is their expertise in viral marketing, attracting significant users with little spend. A key tactic deployed (by both Robinhood and Freetrade), is to encourage existing users to refer new ones by gifting them and their referrer a free share for each new individual they sign up. 

While these platforms have received impressive VC investment (Revolut has raised over $300 million, with Robinhood garnering over $900 million), they are unable to compete with the capital raised by their publicly listed peers. In the future incumbents could use their significant capital to attract a younger audience, and outperform the marketing activity of commission free platforms. 

Social media promotions 

Additionally, UK based platforms must also be mindful of their marketing efforts to comply with FCA regulations on the use of financial promotions on social media. 

Social media promotions are not outright banned but the FCA requires them to to be “fair, clear and not misleading.” These guidelines ensure consumers are not mis-sold products and are aware of any associated risks, as well as rewards. 

Freetrade has used these guidelines as an opportunity to arm their investors with knowledge: 

“We see our customers as long-term investors, not short-term traders. That means they generally have a diversified portfolio of simple products. Ensuring that all of our communications around those products are transparent, balanced and mindful of any investment risks is the key to meeting compliance standards,” Adam Dodds, CEO of Freetrade told ICAEW. 

MiFID II restrictions on paying for deal flow 

A regulatory hurdle likely to impact Robinhood’s imminent launch in the UK, is the MiFID II restrictions on paying for deal flow. This is the practice of sending customer orders to third party market makers and being compensated for doing so. This is banned under MiFID II legislation due to it creating a conflict of interest. The FCA’s enforcement of the EU framework instructs UK firms to ensure that this incorporates the practice of designing their structures so that commission charges are not linked to research or market analysis services.  

Paying for deal flow is legal in the States is legal but Robinhood’s use of it has not been without controversy and resulted in them being fined for selling on orders to high frequency trading firms, resulting in users not receiving the best prices for their trades.  

Conversely, the banning of paying for deal flow is likely to have been a contributor to UK commission free platforms outperforming domestic incumbents to generate the best price of shares for their customers. Recent findings revealed that Freetrade and Revolut (alongside etoro and Trading 212) are up to 20 times cheaper when taking into consideration the spread, conversion, commission, custody fees and stamp duty. 

The need to diversify 

It is also questionable whether services geared exclusively around commission free trading will ever be significantly profitable in their own right. Commission fees are one of many revenue streams for incumbents, with full service platforms also generating income from pensions, funds and asset management. 

Additionally, the range of investments on commission free platforms is relatively limited. For example, Freetrade’s coverage incorporates over 600 UK and US stocks and Exchange Traded Funds (ETFs), a fraction of the 8,000 plus shares (not to mention ETFs, investment trusts, bond and gilts) offered by Hargreaves Lansdown.  

This is unlikely to be of concern to Revolut, who are using their trading services as a means to drive fee paying subscriptions.  

Amit Mohamed, Head of Wealth & Trading at Revolut, says: 

“The trading platform is a very strategically important part of the Revolut ecosystem, but it is only the start of the personal wealth building tools that Revolut will be offering to customers… We expect to make money from stock trading by driving more subscriptions to Premium and Metal for Revolut as a whole, or via commissions when Standard and Premium users trade outside of their commission-free limits.” 

While the longer term fortunes of commission free services is still being tested their introduction has created more choice in the market and attracted a new audience. Irrespective of their sustainability, this creates an opportunity for the wealth management sector to monetise this new demographic of users and keep them engaged.  

 

About the author

Nick Levine is an ACA-qualified chartered accountant, freelance journalist, and former Head of Enterprise at ICAEW with a focus on SMEs