E-brokers defy odds by recording record trading revenue while dropping commissions to zero

Silicon Valley start-up Robinhood may have turned the stock-trading business on its head, but the old-school brokers are fighting back. 

Slashed trading commissions, new offers such as fractional trades, as well as record market volatility, helped incumbents Fidelity, Charles Schwab, TD Ameritrade, E-Trade and Interactive Brokers capitalize on a new class of retail investors.

Most notably, trading revenue isn’t taking the hit so many on Wall Street expected when major brokers announced they would no longer charge for trades. In fact, all the major brokers, expect Charles Schwab reported record trading revenue in the second quarter. 

“If you went back to last October and looked at expectations, many market observers expected trading related revenues would fall off a cliff,” JMP analyst Devin Ryan told CNBC. “It was the inevitable outcome of this kind of constant pressure on trading pricing. What we have seen is that that revenue has been quite resilient in addition to ushering millions of customers into the industry.” 

The industry started a transformation before the coronavirus pandemic roiled financial markets. Last fall, all the major online brokers dropped trading commissions, following millennial-favored stock trading app Robinood. As zero-commissions became industry standard, investors expected the brokerage industry to take hit from the loss of trading revenue.

However, second-quarter results from most of the major brokers showed trading revenues were actually up year-over-year, and hit all-time record at E-Trade, Interactive Brokers and TD Ameritrade. 

Brokers had bet that free trading would bring in new clientele to offset the loss of commissions. But the unexpected macro trend of shelter-in-place has been “icing on the cake” for their bottom line, according to Stephen Biggar, director of financial services research at Argus Research.

“They couldn’t have predicted Covid, and that trading volumes were going to explode with customers staying home with more time to invest,” Biggar told CNBC.

The trading revenue — which includes payment for order flow and commission payments — was boosted by the money the broker’s make from market makers, like Citadel Securities, for executing trades. 

“Even moving to zero and removing the primary mechanism for monetization of the trade, overall revenues that come from trading and order revenues are overall is down just marginally,” add Ryan.

Robinhood is trouncing the other brokers in daily average revenue trades or DARTS, but all of its publicly traded rivals more than doubled their trading volume year over year in the second quarter. TD Ameritrade saw the largest increase in DARTs, at 312{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f} from the comparable quarter last year.

New fractional trading services from the major brokers lowered the barrier for entry for retail investors. Instead of buying an entire share of a company, many brokers now let you buy or sell a portion of it. The trend was first introduced by start-ups like Stash, SoFi and Square, which began offering the service before Robinhood.

The incumbent brokers jumped on the bandwagon, and are seeing a steady uptick in the product’s adoption among their clients.

Fidelity — which is the largest private broker with $8.3 trillion in assets under administration — saw 343,000 accounts use the fractional trade service through the end of July. The Boston-based firm has more than 32 million brokerage accounts. It saw a record second quarter with an all-time high of 1.2 million new retail accounts in the quarter, the company announced Tuesday. Fidelity also saw trading activity more than double year over year, with an average 2.3 million daily transactions in the quarter. 

Of its 12.7 million accounts, Charles Schwab said more than 60,000 clients have used its fraction trading option called Stock Slices. Of 1.51 million users at Interactive Brokers, 136,000 have signed up for fractional trading. TD Ameritrade does not offer stock slivers to its clients. 

“The move of some of these firms to allow fractional trading has just removed one more area of friction in e-trading,” said Ryan. 

The most popular stocks investors are owning fractions of are some of the most expensive and well-known stocks on Wall Street. 

At Fidelity, Tesla, Apple and Amazon — some of the higher-priced U.S. stocks — are seeing the most fractional shares trading activity. Similarly, Schwab said its most popular stock slivers have been Amazon, Apple, Alphabet, Microsoft and Netflix. Apple became the first U.S. company to reach a $2 trillion market cap on Wednesday. 

“Those are stocks that have historically been active retail stocks but not every investor has had access to on every platform,” said Ryan. “They’re popular stocks with retail and they’re popular stocks with institutional investors as well.”

Still, Interactive Brokers EVP of marketing and product development Steve Sanders told CNBC the stock slivers are still for a sophisticated clientele, and are not targeting inexperienced investors, a tactic Robinhood has been accused of. 

“We did not do this because we wanted little small clients with not a lot of money to put their last $200 into stocks,” Sanders told CNBC. “We did this as another tool that we put out there for clients like to deal with even dollars or want to be able to get something large like Berkshire Hathaway at a more managed price.”

“If the end clients is just in there because they’re bored and its another sports venue for them to play with their money and gamble and they’re not doing they’re homework and they just enjoy the ups and downs, I would say that’s a bad thing,” added Sanders. “If the client doesn’t have a lot of money but they’re doing their homework and its a way to get into the market I would say its a good thing.”

As economies re-open, people go back to work, and volatility dies down, retail brokers may not see the explosive growth that saved trading revenue in the beginning of the year. 

Argus Research’s Biggar pointed to the volatility index and trading volume on the S&P 500. In the heart of Covid-related shutdowns, market activity exploded but has calmed down since. The volatility index, or VIX, was above 80 in March and is now down in the twenties. The S&P 500 has recovered to its pre-covid February level,  kicking off the start of a new bull market and notching its fastest recovery in history. But Biggar said he worries about retail investors’ stomach for investing if stocks retreat.

“I think we’ve hit a peak, there’s just less trading than there had been.” Argus Research’s Biggar said. “Brokers are in good shape through year end — maybe the hangover comes comes next year.”

— with reporting from CNBC’s Nate Rattner. 

Subscribe to CNBC PRO for exclusive insights and analysis, and live business day programming from around the world.