European venues and brokers seek to capitalize on the growing retail trading space

Key Takeaways

• Europe lags behind the US but has huge retail trading potential
• Technology has made it easier for individuals to invest
• Brokers face fierce competition and compliance challenges

Stakeholders from across the industry are keen to encourage the growth of retail participation in the European capital markets. Trading venues in particular are pursuing a range of innovations designed to attract retail investment. These changes are likely to have far-reaching effects on European market structures, and broker-dealers need to ensure that they are prepared for the future.

Why is there a focus on retail now?

There is a general feeling across the markets that Europe is failing to capitalise on the potential of its large, wealthy, and financially sophisticated population. In comparison with North America, the proportion of personal capital invested in the equities markets is relatively low. According to EY, only 17% of EU household assets are invested in financial securities such as stocks or bonds, compared to 43% in the US. North America is a mature market for retail investing, where stock holding is normalised for individuals. Both exchanges and brokers are keen to build a similar culture of investment across Europe.

Technological developments have made it easier than ever for individual investors to participate in the capital markets. A wide range of retail focused providers have sprung up to facilitate this access. It’s now easy for the average consumer to invest through a smartphone app, with access to a wide range of asset classes.

Individuals can also choose how engaged they want to get, with retail brokers enabling everything from day trading to fully passive investment. And the widespread availability of investment advice and resources online is also helping to democratise access to the capital markets.

The COVID-19 lockdowns demonstrated the potential of the European retail market. The share of total trading in Europe carried out by retail investors jumped from 2% in 2019 to 7% in mid 2020, as budding investors took advantage of their extra free time and disposable income. Although investor numbers and volumes have since fallen from this high point, markets are keen to lure back as many retail investors as possible. For trading venues, retail represents a huge (and largely untapped) source of potential growth.

Tapping retail trading potential

European venues are taking various approaches to attracting retail investors. Several exchanges have dedicated retail trading services: for example, Deutsch Borse Xetra Retail or Euronext’s Best of Book. Such services aim to pool retail liquidity to achieve better execution.

Exchanges are also attempting to attract investors indirectly by incentivising brokers. For example, by waiving ‘taker’ fees for retail orders that remove liquidity from the market. However, such incentives often come with strings attached, and venues often seek to structure them to fulfil their wider goals. Brokers may be required to route retail orders across multiple other books before they can access fee waivers on the lit book for instance.

For exchanges, the long-term goal is to capture a significant level of retail volume. Liquidity tends to be ‘sticky’; once banks and brokers have established their preferences for where to send flow, they are slow to change. Venues hope to build an unstoppable momentum behind their retail offering and become an automatic first choice for retail order flow.

For venues, the benefits to the growth of retail trading are clear and obvious, but for brokers the situation is more ambiguous. While there are major potential upsides to establishing themselves as a retail broker, there are also substantial challenges. First and foremost, the retail market is highly competitive, and consumers are extremely price sensitive. Brokers need to consider whether it is even feasible for them to be profitable in the retail space.

Compliance matters

Retail flow also brings a greater level of regulatory scrutiny. Regulators perceive retail investors as potentially vulnerable and are closely focused on the quality and level of service that brokers provide. Brokers need to collect, manage, and report on a wide range of data on both retail customers themselves, and their execution outcomes. They need to ensure that their systems are set up to meet these reporting requirements. Furthermore, each of the exchanges that they send flow to will have their own data requirements.

As well as compliance, tools also need to support the unique requirements of retail order flow management. For example, the ability to automate order routing can allow brokers to satisfy venue requirements for retail fee waivers. Controlling costs in this way can be crucial in achieving profitability on retail order flow.

The growth potential of the European retail market means that venues are likely to continue their attempts to incentivise and attract retail order flow. The rise of retail trading also presents a major opportunity for brokers. But to take advantage, they need to ensure that tools and processes are set up for efficient order management and regulatory reporting. To achieve a competitive advantage and deliver profitability, brokers need to optimize their retail workflows.