IG Group has become the latest broker to launch a commission-free US share dealing service. The move comes as the group looks to diversify its revenue streams away from its Spread betting and CFD trading routes.
IG has had a stockbroking and investment division for several years and the business has generated positive revenues and revenue growth, but to date, it has not been able to move out of the shadow of its older and more established sibling. The move to offer commission-free US share dealing is doubtless aimed at increasing traffic and market share for the physical stock trading division.
You may well be asking yourself how can offering something for free boost turnover and profitability?
Well, there are two potential answers to this question: Firstly, IG could be offering commission-free share dealing on US stocks as a loss leader. Tempting share traders and investors into opening an account with the company, in the hopes that there will be an opportunity to sell them other fee-paying services down the road.
Secondly, it’s quite likely that IG could be recouping its outlay through what is known as payment for order flow. This is a process where US market makers and hedge funds pay retail brokers for the opportunity to trade against their aggregated retail flows.
Payment for order flow is frowned upon by the regulators of the UK and European markets but in the USA it’s standard
Payment for order flow was certainly a major factor in the rise of free trading services such as Robinhood, which together with its peers, disrupted the US online broking market to the extent that established major players such as Interactive Brokers and Charles Schwab were forced to launch their own commission-free offerings.
The market makers and hedge funds who buy the order flow do so because they believe they can make a margin on such retail business. That news won’t come as shock to IG however, which as a business has had forty-five years of experience in successfully managing the trading positions and flows of a substantial retail client base.
Even though end clients will benefit from the reduction in, or should that be the removal of dealing charges, there is a nagging doubt in the back of our mind about just why large US institutional traders are so keen to get their hands on retail flows?
One explanation might be the fragmented state of equity execution in the US
Where numerous competing exchanges, MTF’s (Multilateral Trading Facilities), liquidity pools and internalisers vie for business.
Those firms that buy-in retail order flow likely have the technology and know-how to allow them to arbitrage any latency or price differentials, that occur between these competing venues.
We don’t want to look a gift horse in the mouth, but we do wonder if, in the future, that opportunity might be offered to retail traders as well?
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Richard founded the Good Money Guide (previously Good Broker Guide) in 2015 and has been a broker for 20 years most recently at Investors Intelligence and previously a multi-asset derivatives broker at MF Global (Man Financial). Richard started his career working as a private client stockbroker at Walker Crips and Phillip Securities (now King and Shaxson) after interning on the NYMEX oil trading floor in New York and London IPE in 2001 & 2000.