Recent years have seen a resurgence in the concept of trading physical equities, with a slew of new arrivals joining the market for what is arguably one of the oldest forms of investing. But what has been the driving force behind this change in momentum?
There has certainly been no shortage of fundamental factors in play, ranging from anodyne improvements in technology reducing transaction costs, to the COVID pandemic – which initially saw many of those with surplus cash for the first time dabble with investing, before erupting with the meme-stock phenomena of 2021. But the root causes here are arguably rather more nuanced. Leveraged trading providers – many of whom already have sophisticated proprietary technology, weighty research and development budgets – have found the regulatory backdrop becoming ever more restrictive in recent years. And whilst there may be some net uptick in end user demand, this is already starting to look limited, especially for those pursuing a free trading model. Instead, the single most critical factor driving evolution here is institutional counterparties who are looking to access the widest range of assets via a one stop shop, whether that’s for their own consumption on a B2B basis or for distribution on to their own consumers.
So, what have we seen so far? The rise – and partial retreat – of product providers is difficult to miss. Many of these brokers have attempted to use technology to exploit efficiencies and reduce costs to such an extent that they can make the service free for their consumers to use. This however is a challenging play, given a combination of factors such as third party exchange and registry fees, along with government transaction taxes, all need to be accounted for. Someone has to foot the bill and ultimately when it comes to physical equity trading, there’s no such thing as a free trade.
The USA – which has a vibrant and well adopted retail investing scene – has managed to insulate itself from some of these transaction fee challenges with a concept known as PFOF, or Payment For Order Flow. Whilst this can offset headline trading costs, many jurisdictions ban the approach for retail clients, on the basis that it prevents the core best execution principle. And whilst some European providers may have adjusted terms to facilitate functions such as stock lending, the income generated here is unlikely to ever be considered lucrative.
Where does this leave hopes of a renaissance when it comes to trading physical equities? One point that has been laid bare as part of the brokerage service evolution in recent years is that there’s an outright quest for quality. This isn’t particular to share trading, but the rush of new entrants obsessed on delivering this product on a low or no cost basis has exposed the cost and complexity of facilitating on market trading at scale and often in small lot sizes.
Many of those who have ventured into physical equity trading at the discount end of the market, when faced with significant transaction costs that can’t be mitigated, have instead opted to scale back on the customer service offering. That’s fine so long as the technology holds up, but physical equity trading is by its very nature a complex animal. There’s no shortage of corporate actions such as stock splits, rights issues or dividend payments that need to be managed on a day to day basis, in addition to those basic buy and sell transactions. The reality is that problems will arise and a human will be expected to intervene to iron out the inevitable wrinkles.
Critically, institutional counterparties are taking the stance that whilst they want a comprehensive, multi-exchange physical equity offering, they need this to be backed up by an exceptional level of customer service. In turn, this needs to be funded from somewhere and that will typically mean a return to per transaction commissions, either paid for by the institution or the end user. Attempts not to charge here will, as noted above, come either with the inevitable by-product of cross-selling, or with a poor customer service experience in the long term.
This approach also augments the “one stop shop” ethos, which is becoming ever more dominant in terms of multi-asset offerings. For ease of use, reporting, margining and overall account management simplicity, counterparties understand more than ever the benefits of having a multi-instrument and multinational product portfolio all on a single platform and funded from a single currency.
The global CMC Markets organisation already has its own high quality physical share trading platform. Historically, we provided the share dealing functionality for ANZ Bank on an outsourced basis, before migrating the customer base of more than one million over to CMC Markets (Australia). Throughout 2022, we have been working to make this platform portable to other jurisdictions, integrating the improved functionality into our Next Generation CMC Markets Connect proposition. That means as well as being deliverable on a stand alone basis, it can also be offered as part of our wider institutional offering, either as a white label or with corporate clients simply taking an API feed.
However it all revolves around a need to acknowledge that there are real, external costs involved in delivering these multi-asset services, especially when it comes to physical equities. Unlike off-exchange trading, you can’t internalise the whole process, so those who stand to succeed in the long term here without resorting to grey-area practices such as cross-selling products will need to have the confidence to be able to charge for the service. Decades ago, physical share trading was so expensive as to be the preserve of only the wealthiest. We don’t need to return to that paradigm, but as is well known in the market, there’s no such thing as a free lunch.