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Who wins in the race to $0 brokerage? Editor's Note

Emma Rapaport  |  25 Sep 2021Text size  Decrease  Increase  |  
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It's easy to get sucked in by a headline number, especially when that number is zero. $0 upfront, 0% interest, buy one get one free. Why pay for something you can get for free?

But what does free really mean? Economists will tell you there's no such thing as a free lunch. Those of us who spend time online know if we're not paying for the product, we are the product.

In finance, the free lunch is called zero-commission trading. In an industry notorious for hiding fees in complex product disclosure statements, the promise of 'don't pay anything' holds obvious attraction. A phenomenon started in the US has made its way down under, and investors being gouged by up to US$115 to place a trade have jumped at it.

'$0 brokerage' has been limited to international stock trading, but ASX brokers have been forced to respond to the new investor expectations. Online broker Stake threw down $3 ASX trading last week, undercutting its nearest competitor Superhero by 40%.

In a conversation with Travis Clark, chief executive of Marketech, he said the low-cost platforms have cut corners to make their business model viable. Beyond staffing and marketing, ongoing costs incurred by brokers include licencing market data from the ASX, market placement costs and platform administration.

"It might be free brokerage, but they've got to make that money back somewhere," he says. 

How do they make revenue? Collecting interest from uninvested cash and foreign currency transfer fees.

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To trade, some brokers force their users to transfer cash into a pooled account. But will they receive interest on that cash? Not necessarily, and the idle cash can add up. "Pooled banking allows the broker to keep the interest people would have had," Clark says. "At the moment, it's not a massively important thing because cash rates are so low, but it is a cost. It's basically a hidden fee."

Brokers also charge a percentage based foreign exchange fee to transfer between currencies - AUD to USD for example. $0 brokerage is also a way to get investors in the door to upsell premium features like research, charting and buy/sell recommendations.

Critics also point the finger at areas low-cost brokers have found to make savings, namely pooled holdings and removing live data:

  • Custodial versus CHESS sponsorship. We covered this topic in June. The argument goes like this: when individuals trade with a traditional broker, the ASX has a record of them owning those shares directly, tracked via a unique identification number – a HIN. To reduce costs, some discount brokers operate a custodial model meaning they hold the shares on the trader's behalf. An individual's holding may be commingled with other investors or managed under an omnibus trust account structure. This also allows them to offer features like fractional investing. Clark's argument is that pooled trusts open investors to risks that the discount brokers are downplaying – "I'm not saying they will go broke, but they can". If they do, investors become secured creditors and they're forced to chase their investments.
  • Live pricing: Brokers are charged royalties each time a user looks at a live price. To cut costs, brokers limit their data usage by employ delayed pricing or forcing customers to refresh their screens. "For the CommSec free version, they've done click to refresh – when you open the website, it will show you a piece of data (it costs them that much), then you go to another screen (it costs them that much), so that's it's not constantly costing them," Clark says.

So, should we give weight to these arguments when choosing a broker? Clark raises HIN as a major issue, but the low-cost sector is moving to the point where more than half the listed providers on Finder's index are using CHESS. When Stake chose to enter the ASX-trading game with their $3 brokerage, they used a HIN-based model, which in my view is where the sector is heading.

Frankly, I think the importance of having a personal HIN is overblown. Australia is one of the only countries in the world to operate a unique identification-based system. Other markets seem to get by fine with custodial models. Yes, things can go wrong, but I think the relative cost-benefit isn't enough to sway me. It's a factor, yes, but not a material one, in my opinion.

The one benefit I do subscribe to is portability – especially if I want to freely "shop around" for the best commission. 

MORE ON THIS TOPIC: CHESS or custodian: making the right move with your broker

On interest rates and live pricing, these arguments don't hold for me – but then again, they're not designed to. I personally have very little cash sitting in my brokerage account – preferring to keep it in an offset – and I trade so infrequently I think not having to pay for live pricing is a benefit. If you do keep significant cash with your broker, or you're a higher-frequency trader, it's worth considering what you're forgoing with a low-cost broker. Again some do include these services, some don't - check the individual offering.

Beyond individual features, I do think there's a broader issue with our low-fee obsession. I welcome a reduction in the barriers to entry – or the "democratisation of trading". But having some friction is beneficial. It discourages excessive and speculative trading among retail investors. Brokers make money when customers trade, and the more they trade, the more the broker makes. Robinhood is an extreme example of this, 'gamifying' their app with confetti animations (although this has since been scrapped amid scrutiny from politicians and regulators). Morningstar analysis shows Robinhood makes most of its revenue from payment for order flows (outsourcing its user's orders to trading firms) – a structure that incentivises higher-frequency trading, particularly of options. When a business' revenue model is founded on obfuscating its fees, you will get malformed results, and open the door to regulatory intervention.

What is a reasonable price to pay for a trade? With this much competition, it's hard for consumers to make a call. My guess is the price wars will eventually stabilise as low-cost brokers mature beyond 'growth-at-any-cost' and begin pushing their large user-base into premium products. Subscription-based brokers will attract a certain type of consumer, drawn to higher-frequency trading and specialised features. Ultimately, we're watching an industry evolve. Bold disruption is the way we force legacy systems into the 21st century, and it’s the role of those in the know like Clark to make noise and ensure investors are informed. Too good to be true is part of the process of getting to things being good.


Mathew Hodge stepped up to the plate this week to write the Your Money Weekly Overview. His mind, like everyone else, was on China, and how the Evergrande fallout could impact the iron ore price. If you're looking for some background about who Evergrande is and why its collapse has shaken global markets, Lewis Jackson has put together this handy explainer.

For me, the incident serves as a reminder that investors can't just invest on a demographic theme. They need to also understand the fundamentals of the business and country risk. The Chinese government has shown investors this year that it's willing to take drastic action to reign in certain activities, whether it be issuing tough limits on screen time or levelling the playing field on education. Be warned.

Still on Evergrande, Morningstar Hong Kong reporter Kate Lin has been pursuing who exactly has been buying up the company's bonds – and could be on the hook if the developer doesn't make its payments.

In Firstlinks, Graham Hand takes aim at the mixed messages coming out of the RBA on record low-interest rates and soaring property prices. He also explores the value of options and convertible notes issued by LICs and their promise to limit downside risk.

The ESG world is facing fierce criticism. First, accusations of widespread greenwashing in the fund industry. Then, Blackrock's former sustainable investing chief Tariq Fancy published a personal blog decrying ESG as a "dangerous placebo that harms the public interest". A blog from well-regarded New York University finance professor Aswath Damodaran made waves last week denouncing ESG investing as “a mistake that will cost companies and investors money while making the world worse off".

Within Morningstar, there is a diversity of opinion – reflecting diversity among investors. This week, we present an opinion piece from Morningstar's new editorial director of sustainability Leslie Norton. In it, she argues that Damodaran raises some good points, but he’s mostly wrong on his key assumption – namely that ESG is about "goodness".

More from Morningstar:

Under the hood of Australia's most popular 'all-in-one' ETF: VDHG

AGL shareholders spar with board over climate

Why gold is back on these analysts' radar

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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