Incentives for stock traders: EU financial regulators scrutinize neobrokers

Incentive systems at stock traders that are difficult to see through for small investors are being called on by the EU financial watchdogs. It is about the business practice of the so-called "Payment for Order Flow" (PFOF), in which brokers convey customer orders to certain trading venues and receive remuneration for them. Often these are also those traders who offer their offers for free, said the European securities regulator ESMA on Tuesday. "PFOF raises serious concerns about investor protection," complained the supervisors. In most cases the practice is incompatible with EU securities laws. So-called neo brokers, who attract customers with free offers, have seen rapid growth in Germany over the past few years.

ESMA called on supervisors in the member states to give priority to this issue in 2021 or early 2022. It must be looked at to what extent EU regulations are complied with. Because from the point of view of the financial watchdog, the PFOF practice leads to a clear conflict of interests between the company and the investor. It creates incentives for companies to choose the provider who pays the most for the order book instead of the one who achieves the best result when executing the orders for the customers, explained ESMA.

The financial watchdogs also pointed out that brokers are required to disclose the PFOF practice to their customers. ESMA specifically reminded zero tariff stock traders that they had to give their customers fair, clear and non-misleading information about all costs and fees. Advertising with free services could lead small investors to speculative behavior, they warned. The financial supervisory authority fears a possible conflict of interest because the neo brokers such as Trade Republic, Justtrade, Gratisbroker or Smartbroker can only offer the very attractive conditions for private investors because they receive reimbursements from their partners in securities trading, the so-called market makers.These so-called kickbacks enable neobrokers to have significantly lower fees than banks or other securities firms.

The supervisors should investigate whether their customers suffer disadvantages elsewhere. In particular, ESMA should examine whether the reimbursements for trading orders meet the requirements of the EU Financial Market Directive (Mifid 2) with regard to conflicts of interest, best possible execution and incentives.