It all seems so simple: customers need only make a few clicks on neo-brokers’ online platforms or trading apps to buy or sell securities. And it is all possible (almost) 24/7, thus even outside the regular trading hours. The fees the neo-brokers charge for these services are also temptingly low. Some even advertise that their services are free of charge.

Investors should be careful not to fall for the advertising claims made by neo-brokers. The truth is that even these brokerage services are not free of charge. While the neo-brokers themselves may not charge their customers fees, there are definitely costs involved – only they arise elsewhere. In particular, customers are the ones to bear transaction costs that result when neo-brokers route the orders to market makers. Anyone wanting to trade through a neo-broker should keep this in mind. It particularly applies to anyone eager to trade outside regular trading hours, as this bears a potential risk of higher trading costs.

Trading through neo-brokers

Neo-brokers route orders either directly to a market maker or to a trading venue, where a market maker then also acts as a counterparty to the order. The market maker, sometimes called a lead broker, ensures that the securities can be traded on a trading venue by buying them from customers and selling them to others or else by purchasing them from other market participants. The prices for executing the customer orders are quoted in the form of bid and ask prices.

Market makers earn a margin based on the spread between the bid and ask prices, i.e. depending on the difference between the buying and selling prices. As a rule, market makers pass on part of this margin to the neo-brokers to ensure that as many customer orders as possible continue to come in from the neo-brokers. This is known on the market as “payment for order flow”.

Limited service offerings

Another thing investors should bear in mind: since the low-price model needs to be profitable for neo-brokers, the range of services they offer is usually restricted. For one thing, the selection of available trading venues is very limited. As a result, customers are not fully capable of comparing prices. What is more, neo-brokers do not always offer all types of orders for every trading venue. Their offerings often exclude limit orders, stop-loss orders or stop-loss-limit orders, for example. For some individual trading venues, only quote request orders are possible. Customers are then forced to send the market maker a request for a quote.

BaFin’s perspective on neo-brokers

BaFin monitors neo-brokers for compliance with the rules that apply to all brokers. No simplified supervisory requirements or exemptions from standards designed to protect consumers apply to neo-brokers.

As for the compensation they receive from market makers, neo-brokers are required to disclose these payments to their customers. Customers will have to foot the bill – even when no fees are charged by the neo-broker upfront, the customer has to pay the market maker’s margin. Consequently, BaFin keeps an eye on whether the neo-brokers nonetheless advertise their services as being free of charge – and some neo-brokers still do so. The situation becomes difficult when neo-brokers have their offices in other countries, where BaFin has no intervention powers. Furthermore, neo-brokers are required to use the full amount of the compensation they receive to improve the quality of their services. These providers also have to be aware of the fact that, as a matter of principle, they are not permitted to utilise the compensation to finance the general costs of securities trading or to implement minimum supervisory requirements.

In addition, neo-brokers are required to execute orders in a way that enables the best possible outcome for customers. When considering which trading venue or market maker to route orders to, they should not be influenced by the amount of the compensation they would receive from a market maker, for example. If a neo-broker offers customers several trading venues to choose from, these venues should be presented in such a way that customers can select the option that best suits their purposes. In other words: neo-brokers must not let themselves be influenced by the amount of compensation, also when assessing the trading venues.