How Much Will Commission-Free Brokerages Impact Traditional Brokerages?

The success of commission-free brokerages such as Robinhood prompted traditional brokerages such as Charles Schwab (NYSE:SCHW), E*Trade Financial (NASDAQ:ETFC), and TD Ameritrade (NASDAQ:AMTD) to slash their trading commissions by over 35% in February 2017. Robinhood started as a simple free equity trading app in 2014, and later added pre- and post-market trading options, as well as lines of credit among its suite of offerings. The company now has a customer base of over 2 million, and recently raised $110 million at a valuation of around $1.3 billion. If investors continue to flock towards commission-free brokerages, there will likely have to be further commission cuts in the future for major brokerages. This could result in a 5-10% decline in our valuation for Charles Schwab, E-Trade, and Ameritrade, unless these companies can offset brokerage revenue pressure with other services.

It is interesting to note that the sharp jump in Robinhood’s valuation hasn’t coincided with a decline in the market caps of big brokerages. In fact, E-Trade and Schwab’s stocks have rallied by almost 50% in the past year, driven by the growth in interest earning revenues related to the Fed’s interest rate hikes.

Potential Downside Risk To Big Brokerages

We believe that at the moment, the reduction in brokerage commissions and increased competition from commission-free brokerages will not have a major negative impact on the big brokerages. While these competitors will likely to continue to add younger customers, we expect that many more established customers will value their relationships with traditional brokerages due to better risk management, financial advisory (human and robotic)  and other value added services. However, if commission-free brokerages start providing these services at a reduced cost, just like they started offering credit and after-hours trading at a nominal charge starting at $10, the traditional brokerages may be compelled to cut their commissions further. Here, we look at 2 scenarios:

You can further slash the Revenue Per Trade driver on our platform and check its impact on the brokerages’ stock prices:

However, the downside could be larger than mentioned above. The brokerages generate a large portion of their income from interest on client funds. If they continue to lose share to low-cost competitors, any losses of client assets could put further pressure on their top lines.

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research