Ban on Payment for Order Flow Threatens Revenue: Four Tips for Online Brokers

December 20, 2021

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The EU Commission is banning online brokers from using payment for order flow (PFOF) and similar measures, posing a significant threat to numerous providers’ business model. Additional customer fees are an effective way to make up for losses, and there are four fee types that are particularly promising.

It’s official. The EU Commission is set to ban payment for order flow fees in retail brokerage. A recently published draft reform of the European Union’s regulation of financial markets (EU MiFID/MiFIR Directive 2014/65/EU) states “Investment firms acting on behalf of clients shall not receive any fee or commission or non-monetary benefits from any third party for forwarding client orders to such third party for their execution.” Once this comes into force, PFOF, which is the compensation online brokers receive from third parties for forwarding client orders to third parties, such as trading venues and exchanges, will be history.

Ban on payment for order flow is only the first step

The revenue model of leading European online brokers is in jeopardy. While PFOF typically accounts for only three to five percent of brokers’ total revenues, the ban is the clear first step of a regulatory strategy that has long been feared in the industry, which aims to prevent hidden remuneration in securities trading. The next logical phase will likely be a ban on reimbursements, such as for certificates or leverage products, from product issuers, which would destroy between 15 and 20 percent of renowned online brokers’ revenues.

Experts expect significant revenue losses

In addition, the revenue stream from fund maintenance commissions has come under fire since the introduction of MiFID II. Depending on the platform, this income source accounts for between 20 and 30 percent of brokers’ total revenues. These figures combined with those from the PFOF ban reveal a bleak picture of the future. In the medium term, about half of top European online brokers’ current revenue streams will be at risk. Low- and zero-cost brokers, which are currently thriving, will have to change their entire business model, since payment for order flow revenues account for over 25 percent of their total revenues.

Additional fees for customers as a solution

Online brokers and the retail and regional banks at risk have no time to waste. They need to rethink their revenue models. We recommend compensating for the lack of PFOF income by charging customers service fees. There are four fee components, where customers pay direct or visible fees for high-quality services, that are particularly profitable.

Recurring fee components:

  1. Due to their immediate nature, recurring platform fees and custodial fees are particularly well suited to monetize, for example, the performance and stability of the trading platform or value-added services (e.g., charting tools, research) for specific target groups.

Variable fee components:

  1. Brokers and banks can increase trading venue fees or introduce interchange fees to compensate for the loss of PFOF rebates on the spot.
  2. Platforms with significantly strong foreign trade business can also implement foreign exchange fees by increasing the markups for exchanging foreign currencies. These would be charged, for example, when purchasing a share in dollars from a portfolio in euros. In an international comparison, German and Austrian investors, for example, pay significantly less than Swiss investors, meaning there is room for improvement.
  3. Finally, transaction fees, which have decreased in popularity in recent years, are still an attractive option. Since many online brokers are charged partly fixed and partly variable costs per trade by their securities service providers, this fee component cannot be (almost) zero over the long term. End consumers of these services can, of course, demand that costs do not fall on their end of the value chain. However, it can be argued that the added value of safe, fast, and error-free execution is worth a fair price.

In the medium term, the top online brokers in Europe will need to increase the visible fee level for end customers to compensate for the revenue lost from banned fees, and low- and zero-cost brokers will need to adjust their revenue model to ensure a profitable business model. If they follow these measures and act quickly, online brokers can secure the future of their business.