"Driving people into this gambling is dangerous".

Capco digital expert Alexander Braun talks about the regulatory cudgels against neobrokers, why refunds are not the problem and what he recommends to fintechs who want to build a sustainable business model.

In the US, neobroker Robinhood has been in the crossfire of the Securities and Exchange Commission (SEC) and various politicians for quite some time, who want to stop gamification, but also the fundamental business model of the neobroker. In this country, Trade Republic and Scalable Capital, both worth more than a billion euros, are struggling with similar issues. Alexander Braun, executive director at consultancy Capco sees some problems rolling in for fintechs and blames them for part of the blame for risky and pernicious gambles.

Mr. Braun, discount brokers like Robinhood, Trade Republic and Scalable Capital make a lot of money on rebates. What annoys customers about this? Both the EU Commission and the SEC in the USA are currently taking a very close look at some parts of the business model. This includes rebates, i.e. the money brokers get from market makers for executing clients' trades through them. Because neobrokers have little other income, they are particularly dependent on rebates. The accusation, therefore, is that they are systematically giving "small" retail investors worse prices than they get through regular exchanges. In my opinion, however, there is not much to this. Because already today anyone can have this checked and obviously not much has come out of it.

In the US, Robinhood had to make two large payments precisely because of this. Measured against the total trading volume, these were rather isolated cases. There is no system behind this that favors the big hedge funds over the small retail investors. This thesis may sound good, but it does not correspond to reality.

The supervisory authorities are currently taking a very close look at this, both in the USA and in Europe. Is the regulatory cudgel looming in spite of everything? Both regulators are currently looking at the issue of reimbursement and whether the business model is in the interests of investors. If they conclude that it is not, the current neobroker business model will be threatened. But that would also hit the established banks and brokers who also live off the rebate, albeit less dependent on it in percentage terms because they have other revenue streams. I don't think that's coming though, I think the dangers for the neo-brokers lie elsewhere.

I last got an email from Trade Republic announcing two new features: The first was even more derivatives, and the second was the ability to realtime fund the account for custody via credit card and ApplePay. That made me think twice that this probably isn't in the best interest of sound investing.

Alexander Braun, Capco

What do you think is the danger there? Rebates for risky derivatives or cryptocurrencies are much higher than for stocks or ETFs. At Robinhood, they account for over half of total revenues. This creates an economic incentive to sell instruments that are not in the interest of sustainable investment. This development is also to be feared in Germany. I last got an email from Trade Republic announcing two new features: The first was even more derivatives and the second was the possibility to top up the account for the securities account in real time via credit card and ApplePay. That made me think twice that this probably isn't in the best interest of sound investing. After all, trading on credit is surely the worst thing you can do, and derivatives carry an enormous amount of risk. This is something a neobroker can really only recommend to an investor for one reason: economic interest.

Neobrokers always say that the percentage of investors who trade in risky products is extremely low. Is that true?

We can't look into the German figures at the moment, but the stock exchange prospectus for Robinhood gives an idea of how the figures look in Germany as well. In fact, derivatives only account for 2.5 percent of the total value of portolios, but at Robinhood, this 2.5 percent is responsible for a full 38 percent of revenues. 38 percent - there's obviously an economic incentive to lure people into just such securities. Trade Republic says its rebates range from three to nearly 18 euros, with the upper end of that range certainly accounted for by derivatives. There's a big margin in that. Driving people into this gambling is dangerous, especially with young people who can quickly burn their fingers or even accumulate debt.

It's too short-sighted of neo-brokers, but also established ones, to grow strongly by selling risky products to young people

Alexander Braun, Capco

There has already been a case in the US where a young person committed suicide because he thought he had lost a lot of money. Do you see the danger of neo-brokers pushing young people in this direction?* I definitely see the danger, and it is also a topic that we recently dealt with in a trend study. It was about financial health, which is becoming an increasingly important topic. It is too short-sighted of neo-brokers, but also established ones, to grow strongly by selling risky products to young people. Because if the stock market collapses and prices go down, I'm afraid we could see more cases like that. That would be fatal and no one can want that!

What do neo-brokers need to do? They need to build much more on a sustainable business model, where they introduce investors to the complex structures through financial literacy and don't lure them into single meme stocks like Gamestop or cryptocurrencies like Bitcoin or Dogecoin in the short term. We need more financial health. Sure, most of the time the use of these apps is designed around the usability guideline "Don't make me think," but that's fatal when it comes to finance.

If this self-regulation doesn't happen, the regulators will have to.

Alexander Braun, Capco

You mention app design, which has often been criticized for gamification in the past. Is that going to change?

I think that's the first starting point for regulators - at least in the US, where gamification is much more prominent than in many apps here. Robinhood already had to remove the confetti cannon that lights up when you've bought something. Supervisors will also take a close look at smaller spurs called "dark patterns," such as making the button for "buy" larger than the one for "cancel purchase," and prohibit them if in doubt. Neobrokers can get ahead of this by removing gamification, which has been shown to create a degree of dependency, from securities trading. If that self-regulation doesn't happen, the regulator will have to.

What advice would you give to neobrokers in the long run?

So far it hasn't translated into user numbers, but should the market crash, many users will get their fingers burned and pull out of securities investing. The hype around Dogecoin alone accounts for a third of all crypto revenue at Robinhood. When that comes to an end, it will be reflected in the business. Neobrokers, instead of relying on such short-term gains, should therefore focus on encouraging their customers to make informed investment decisions to enable users to build wealth over the long term - not to gamble in the short term. That is not sustainable.

Thank you very much for the interview.

Personal details: Alexander Braun is a digital expert at Capco, a global management and technology consultancy for banks and financial services providers. He has 20 years of experience in consulting, specializes in the challenges of digital transformation of corporations and supports companies in building new digital business models. For years, a special focus has been on the German fintech industry.

*Editor's note: We have chosen to be reticent, if at all, about reporting on suicides or suicide attempts. The reason for our restraint is the high copycat rate following any coverage of suicides. If you feel affected yourself, please contact the telephone counselling service (http://www.telefonseelsorge.de) immediately. On the free hotline 0800-1110111 or 0800-1110222 you can get help from counsellors who in many cases have been able to show ways out of difficult situations.