Article by Samantha Sharf
Late last month I moderated a panel at the TradersExpo, a three day conference hosted by MoneyShow to bring active traders together mostly to learn about and discuss strategy. Our panel featured three companies from FORBES’ Fintech 50 list—IEX, Motif and Xignite—and focused not on techniques for trading, but on the future of trading.
A nice thing about getting representatives from these particular companies together is that they are not competitors. Each one is tackling a different piece of the trading process and trying to improve it.
Xignite organizes and packages financial market data for more than 1,000 financial companies to use in their apps and websites. Motif invites investors to design, share and buy themed ETF-like portfolios of stocks. And IEX aims to makes the hidden process after an investors hits buy or sell more equitable by inserting a “speed bump.”
What follows is a, lightly edited, snippet from that conversation. About halfway through the hour-long panel I asked about fractional share trading, which makes it possible to take a position in a stock without buying a full share or a whole number of shares. After some talk on the logistics of this, the discussion seamlessly turned to disruption more broadly, why big banks have largely failed to innovate and signs of an emerging true between finance incumbents and fintech startups.
Stephane Dubois, founder & CEO, Xignite: What the industry has done over the last few years is really lower the cost, lower the friction around investment. Ask yourself, why didn’t the big Wall Street firms invent fractional shares? It used to be you’ve got investment advisors managing your account, otherwise it was all just self-directed. These were the two poles you could choose from, there was nothing in the middle. Now what we are seeing are tons of new companies, Motif and others, innovating, using fractional shares and trying to do zero cost trading.
But why did that happen? What we have seen, as a provider to the fintech players, is that post-mortgage crisis, post-2008 the banks almost forgot they had customers. They have been buried in regulation, they have been focused on all the things the regulators force them to do and thy stopped innovating, whether it was the front end services they provide their clients or the type of technology they offered. It was still high cost, therefore [the thinking was] “I can only service people who have a lot of money in their accounts via advisors.” Meanwhile, they opened a huge avenue to Hardeep and other guys in Silicon Valley or New York or London to invent a lot of this. This is why it is coming from Silicon Valley. It is about cost and friction.
Hardeep Walia, founder & CEO, Motif Investing: It is. To give some credit to the big firms, and not just because they are investors in our company, it is hard to move a tanker. It’s the classic innovators dilemma, how do we go in? There have been innovations in the past, but think about it, if a traditional online broker were to offer what we do—30 stocks for the price of one, or 33-cents a stock ticker—they wouldn’t be in business. [Motif charges $9.95 for baskets of up to 30 stocks, $4.95 to trade individual stocks.]
You see this across technology, with the move to the cloud, all of these things shake up the economics. What drives a lot of the change is that most people don’t know that your typical online broker makes more money holding your cash than from trading. E-Trade, 68% of their revenue comes from holding cash, very little of it comes from trading [double checked this, in the most recent quarter E*Trade earned 63% of its revenue from operating interest income, 22% from commissions]. A lot of the models of investing are changing very dramatically. Nobody out there can make money at 33-cents a stock ticker, we do. That’s the part that’s changing.
For the big guys, they have advantages of scale. Unlike Uber challenging the taxi industry, Wall Street is very smart. They know what they want to do and they actually want to participate in this. That is why they invest in our company. They have the challenge of an incumbency. When you are very very big it is hard to move and innovate fast enough. But it’s happening, you’re seeing now more and more and more that this is a very different scenario than the traditional David versus Goliath where a small tech startup goes in [and defeats the big guy].
The big guys get it, which is something most people don’t realize. They see what their role is. You see Jamie Dimon [CEO of JP Morgan Chase] writing in his letter: “Silicon Valley is coming.” Silicon Valley is coming. The question is what do you do about it? That is the part that is going to be interesting, to see what happens as we work together and figure out new models. This is not an industry that is fighting change, at some level they’ve got to figure out how to transition to this new model.
Laurence Latimer, venture strategist, IEX Group: Let me add, I would say some parts of the industry are not fighting change, other parts of the industry are fighting change. One of the things that has been most relevant for us as an exchange is getting to understand the transparency that happens once you press go. When you send your order down through your retail account there are a lot of way that the trade and the information you put in that trade can be utilized by your brokerage and other downstream participants. If you follow the money, particularly for larger incumbents there is a reluctance to get too far ahead of the curve because it strikes at the heart of their business models. Startups are bringing the types of transparency and options particularly at retail but also at the institutional level to make smarter decisions about the information they get, how they trade and also what happens after they hit go on that trade.
Walia: Is part of that the fact they don’t see that? How do you then get people to care?
LL: Yes, exactly. You’re talking about 33-cents a trade, what you are seeing on the retail side is that 33-cents. You’re not seeing everything that is happening to your order that your broker dealer is facilitating. They are making money somehow. On the consumer side, many of us may have a Google account, a Gmail account. We think about it as free but it is not free. If you look at the advertising revenue Google gets globally each user is about $24, $25 to Google each year. In this case you are the product. For many of your broker dealers on the retail side you are also the product, your order is their product and they are making money somehow. Part of what IEX is trying to do is make sure that there is increased visibility and increased transparency around what happens after you press go. It is a very small time frame that is considered real time, but a lot can happen in real time that is not necessarily to your benefit.