Investors can be split in two main categories: institutional and retail.
Institutional investors can be likened to wholesalers buying flowers in bulk from farmers:
they spend money on behalf of their clients and tend to make large-scale investments.
It’s their full-time job.
That’s a lot of flowers!
Retail investors are more like me, buying a bouquet of tulips with my own money.
Their purchases are smaller and typically require a middleman, like a florist.
Thanks!
And just like online flower delivery companies have made getting your bouquets easier,
platforms like Robinhood have made markets more accessible than ever.
I heard that there was zero commission trades and I thought okay that’s awesome,
then I can trade more frequently and not feel bad about it.
Trading activity from retail investors has skyrocketed as a result.
But in Europe, the number of people buying and selling shares remains very low.
Many of the states in continental Europe are built upon a statutory pension system
which is, frankly speaking, 100 years old. And so there would not be any promotion of
private retail ownership of stock markets in society, right.
So basically, Europe is missing 10 to 20 years of that culture.
So why is this?
And with technology changing the way we trade, could European retail investing finally bloom?
To understand why retail investing isn’t very big in Europe,
it helps to look at why it is big in the U.S.
American households own $38 trillion worth of equities, either directly or indirectly.
That’s nearly 60% of the entire U.S. equity market.
Christian, it’s great to finally speak with you face to face, almost.
Christian Hecker is the co-founder of Trade Republic, an online broker based in Germany.
Why do you think U.S. players have struggled to build up a presence in Europe in the past?
Well, I think the U.S. market and the European market are structurally very different,
especially due to the lack of the 401(k) structure in Europe.
Unlike a traditional pension which guarantees you a certain income in retirement,
a 401(k) depends on the contributions you make throughout your career.
With a 401(k), you choose your own investments, and your account balance fluctuates based on market gains or losses.
That means the responsibility falls with the individual rather than the state.
In the U.S., there aren’t many sort of social welfare apparatuses in place anyway,
so it’s sort of like the onus is on you to invest for your retirement.
With no 401(k)s to encourage individuals to invest for themselves in the EU,
savers have little direct interaction with stock markets.
Instead, statutory or state pensions are more common, leaving investment decisions
to governments or large financial institutions. But there are other factors at play as well.
There is a perception perhaps from the retail investors that access to capital markets is difficult,
and probably reserved only to wealthy people. So, there is a change of perception which is needed.
Ugo Bassi is a top official for the European Commission’s financial services unit.
The main issue is about trust, and the best way to build trust
is to set up rules which are flexible enough in a way,
but also which protect the investors and makes the investors feel protected.
Europe has seen retail investor participation double since 2020,
but it’s still lagging behind other parts of the world.
One piece of research estimates that retail activity makes up only 5-7% of total trading volume in Europe,
compared to over 25% in the U.S. and over 60% in China.
Despite that, there is a slew of start-ups in Europe trying to take advantage of growing interest.
They include Revolut, Trading 212, Freetrade and Trade Republic.
These new trading applications typically offer zero-commission investing
and include ‘gamified’ features to encourage participation as well.
I spoke to Eric Liu, an analyst at Vanda Research, who tracks U.S. retail trading activity.
We’re kind of at a crossroads in Europe. And so, you’ve seen a number of
very successful kind of smaller companies attempt to do what Robinhood has done here in the U.S.
What’s driven the boom in your view?
In Europe many people have realised that the statutory pension system of the state
is not working any more, right. And so, they face a massive pension gap
and they figure that participating in capital markets is really one source to solve the problem.
And so we’ve seen millions of people entering capital markets for the first time in their lives.
So, could this be the catalyst Europe has been waiting for?
Are we going to see a boom in retail investing?
It is a very complex and interesting issue. The digital transformation is certainly a
very positive element of the effort that we are doing to try
to make the retail investor close to capital markets.
On the other hand, of course, it’s a phenomenon in general
which needs to be kept a little bit under control.
Among the risks policymakers and regulators are most concerned with
are those associated with ‘payment for order flow,’ something the European Commission is planning to ban.
Payment for order flow is what makes trading on platforms like Robinhood free.
Back in the day, I couldn’t buy stocks off an app. I had to make a call to my broker,
who would then call the stock exchange to make the trade for me.
The broker charged a hefty fee for the privilege.
Now when you buy stocks on one of these new ‘free’ trading services,
they send your purchase on to another company that makes the trade actually happen.
This middleman company, called a ‘market maker,’ needs both buyers and sellers in order to make their business model work.
That’s why they pay companies like Robinhood for your trades. Hence the term ‘payment for order flow.’
Payment for order flow has been in the market for a very long time.
It’s used by big banks and by insurances alike and it’s really the
driving force behind lowering commission fees which is especially
empowering lower income families to trade for a reasonable cost.
This model makes trading cheap. It makes it easy,
but regulators argue it’s also risky and doesn’t have the interests of retail traders at heart.
These risks include potential conflicts of interest when a trading platform routes an order to a middleman
for their own benefit, or when a market maker doesn't offer the best price for a trade.
The policymakers have to try and find the right balance between, on the one hand,
flexibility and encouragement and promoting all the new tools and instruments and trends,
which of course help to reduce costs, help to make people more attracted
and more interested in investing, but on the other hand we should not
underestimate the risks that this entails and investors should be fully informed about those risks.
For many people, financial products and services remain complex.
In fact, “What is the Stock Market” is the most common FAQ page visited by Robinhood investors.
So, if Europe bans the payment for order flow model,
is it possible for a platform like Robinhood to exist in Europe?
And if not, is retail investing on the continent here to stay?
This is a trend which will have no coming back. It’s like social media, once this is open,
the pandora box is opened, then you won’t get back.
I think they’re here to stay, like, I basically intend to continue, you know,
investing all my discretionary income in the market in some capacity.
In terms of the importance of retail investors over the past year and a half, that’s not gonna change.
And I think the cat’s out of the hat and at this point,
I think everyone is going to need to follow retail investors going forward.