'How Do We Compete?': Invstr Founder Kerim Derhalli On The Brokerage Pricing War

Kerim Derhalli, CEO at Invstr, spoke with Benzinga about the future of trading without commissions, including the importance of education and market awareness.

Background

Following Robinhood’s pioneering of the large-scale, commission-free retail trading model, many established brokerages have since followed suit.

“Commissions have been in decline, both in the institutional world as well as in the retail world," Derhalli said. 

The brokerage pricing war began when Robinhood tapped high-frequency market making firms like Citadel Securities to execute and providing remittances for large volumes of routed orders.

Retail brokerages adopted this model from institutions, the Invstr CEO said. 

“Institutions would hand over those orders, and the market makers would pay them a fee — payments for order flow.”

Market makers pay fees on order flow due to the additional volume from which a profit, the bid-ask spread, can be extracted.

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How Do Brokers Make Money?

Even with commission-free trading, brokerages can make money three ways, Derhalli said: 

• Payments for order flow.
• Interest on account deposits lent in the interbank market.
• Lending of customers’ securities for shorting purposes.

The Problem: ‘Clients Are Dying’

Traditional brokerage models no longer work the CEO said.

“There’s a whole generation of savers and investors growing older. The new generation — the Millennials and Gen Z — typically don't want to open a brokerage account." 

Newer market participants are looking for friendlier options, like fintech robo-advisors, he said.

“Existing clients are moving on. So, we need to find a way to attract these younger clients. Who’s doing that? That’s Robinhood. How do we compete?"

Robinhood is offering things free, "so we need to offer things for free," Derhalli said.

The Real Cost: Execution

For many participants in the market, especially those who are inactive and only trading a few times a year, commission-free trading is advantageous. Issues arise with an increase in trading frequency.

“In this new world, the client comes in and says, 'I'm a zero commission client and I want to sell this particular stock.’ The broker now says, ‘OK, you're a zero commission client and we have to trade with the best bid and offer; the best bid right now is $10, so I'm going to fill your order at $10,’” he said.

“It could be that if they put their stock to sell at $11, they would have been filled.”

Derhalli expressed great concern over orders not being executed at the best available price in the market.

At times when the market is extremely active, market orders can be filled between the bid and the ask, or mid-market price. Now, however, without commissions, brokers and market makers are less incentivized to pass on such price improvements, he said.

When the frequency of orders is much higher, price improvements matter, Derhalli said.

See Also: How And Why Are Online Brokers Offering Commission-Free Trades?

Are Education, Fintech The Answer?

Derhalli suggested traders enroll in online investing courses like the Invstr Academy, an reflection of his mission to help traders become profitable via collaborative empowerment.

Through Invstr Academy, traders learn key principles and test their skills risk-free via a simulator.

“People naturally learn by playing with other people. So people can learn about the markets, build up confidence and practice their skills in a social [environment].”

Once they're comfortable, traders can risk real capital through Invstr, trading fractions of shares on a commission-free basis.

“The big difference with Invstr is we help people build confidence by making it fun, build that knowledge through Invstr Academy, then we make it affordable for people to invest through fractional investing."

Photo courtesy of Invstr.