What do platforms like TradeRepublic, Revolut, DEGIRO, BitPanda, and eToro have in common? They are neobrokers or offer digital brokerage services, making investing more accessible and affordable for retail investors across the EU. However, they can differ significantly in their operations and product offerings. Some provide riskier financial products, while their business models and pricing structures can affect execution quality, influence retail investor behaviour, and impact investment outcomes.
Let’s dive into how neobrokerage models work – exploring their benefits, pitfalls, and what retail investors should be mindful of.
What are Neobrokers?
Neobrokers are digital platforms that offer low-cost, self-directed investment and trading opportunities for individual investors. They provide seamless access to financial markets through a range of products, including stocks, ETFs, and often promote fractional investing. Some also offer cryptocurrencies or higher-risk instruments like derivatives and leveraged products. Known for minimal to zero explicit trading fees and seamless (app- or web-based) interfaces, neobrokers have made investing more accessible and affordable. However, indirect costs linked to revenue mechanism – such as payment for order flow (PFOF), or opportunity costs (currency conversion fees or spreads, etc.) often apply. While neobroker platforms promote financial independence and innovative automated tools enabling cost-averaging strategies, their design can also encourage impulsive transactions. Gamification, simplified interfaces, and one-tap investing may drive frequent trading at the expense of sound financial planning. Careful consideration is key; investors should thus prioritise long-term wealth-building and informed decision-making.
Challenges of Neobrokers
Despite their advantages, neobrokers pose certain challenges for retail investors and the broader market. For instance, while they promote a "zero-commission" model, this can be misleading, as investors may still incur implicit costs beyond the explicit ones.
Implicit costs are indirect expenses often associated with bid-ask spreads and trade execution quality. These costs may go unnoticed or remain undisclosed, potentially impacting investor returns and overall investment outcomes.
On the other hand, explicit costs are direct and clearly disclosed expenses, such as subscription fees, transaction/execution charges, or account maintenance fees (custody fees), which investors are aware of upfront.
Inducement and conflict of interest
A key challenge with neobroker platforms is that Payment for Order Flow (PFOF) (soon to be banned by 2026) and rebates are central to their business model. PFOF occurs when neobrokers receive compensation for directing retail orders to specific market makers or trading venues, while rebates are payments from ETF providers and asset managers for product listings.
While PFOF and ETF rebates help keep trading costs low, they raise concerns about market transparency and investor choice. Moreover, such subsidies may ultimately increase the Total Expense Ratio (TER) of ETFs and, therefore, negatively affect their performance over time.
Security Lending Risks
Another revenue-generating practice that may be used by neobrokers (and traditional online brokers alike) is securities lending; where clients' securities are lent to third parties – often short sellers – while the broker retains the collateral received and may profit from its use. While this practice can generate additional income for brokers and may help lower operational costs for clients using their platform, it also introduces risks for retail clients, including counterparty risk, collateral shortfalls, and potential impacts on their shareholder rights (such as voting at companies' general meeting).
Challenging the Regulatory Framework
The innovative nature of neobrokers challenges existing regulatory frameworks, requiring ongoing scrutiny of adaptations to ensure investor protection and market integrity. It is essential to foster a consumer-centric ecosystem built on awareness under fair, clear, and non-misleading information, while ensuring that services align with clients' best interests.
Thus, it is imperative to implement regulatory frameworks that ensure sound integration of technology-oriented financial services. Such practices include:
- Regulation of marketing and behavioural practices: address marketing strategies (including 'finfluencers'), gamification tactics, and behavioural prompts that may mislead investors or encourage excessive trading. This includes digital engagement practices or social trading ensuring that features like push notifications, rewards, or prompts do not promote speculative/risky behaviour.
- Transparent Execution and Communication: Ensure clear disclosure of investment risks, trade execution details (including spreads and fees, execution venue), potential conflicts of interest, and counterparty risks.
- Enhanced Investor Awareness: Improve understanding of high-risk investments and strengthen oversight of digital platforms, ensuring transparency, risk warnings, and responsible (educational) design to protect non-professional retail investors.
- Retail Investment Strategy: Consider bans on inducements; specifically the partial ban prohibiting inducements in execution-only services to enhance investor protection and reduce conflicts of interest.
- PFOF Ban: MiFID II/MiFIR will prohibit Payment for Order Flow (PFOF) practices to mitigate conflicts of interest and ensure best execution for retail investors.
Service diversification – To go further
Fintech such as neobrokers are increasingly integrating brokerage services with banking, savings, and payment solutions—often under a "platformisation" or white-labelling model. This integration can blur clarity for clients and expose gaps in regulatory oversight. So, the question arises: Is the advent of integrated financial platforms as a "one-stop-shop" truly the solution?
For all self-directed solutions, particularly those offered by neobrokers or neobanks, while they offer significant benefits, they also raise questions clients should consider:
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1. Understanding What You’re Signing Up For
Integrated platforms can combine investment services, savings accounts, and payment services, making it harder for new clients to distinguish or understand the mechanics between them. This streamlines investment while adding new awareness complexity is often due to intermediated services, which further complicate understanding of the risks and protections involved.2. Clarity on Protections and Regulation
Choose a regulated firm, preferably based in an EU country, to ensure clear regulatory oversight. Clients should verify whether their securities are held with a depository or further intermediated and ensure that their securities accounts are properly segregated, as this is crucial to the protection of their assets.3. New Featured Products
Some platforms feature investment products like money market funds (MMF) or fractional shares. Fractional shares can either represent co-ownership of real securities or be a derivative, which adds complexity and risk. Unlike traditional savings accounts, MMF products are subject to market volatility, liquidity, and counterparty risks, and may result in capital losses.4. Hidden Costs and Fees
Although many platforms advertise zero-commission trading, hidden costs such as spreads, payment for order flow (PFOF), and internal execution practices can affect trading pricing. It’s crucial to understand the full cost structure, especially with freemium or subscription models. There’s no such thing as a free lunch – despite their competitive advantage, neobrokers often embed costs or offset them with other fees. Ultimately, investors should assess whether the benefits justify these hidden costs.5. Frictionless Trading: A Positive Nudge?
The ease of trading via linked accounts, debit cards, or automated investing – but also prompts and interactive engagement can encourage impulsive trading, increasing risk exposure and potentially affect long-term returns. Investors should be mindful of their trading behaviour to ensure they are making informed and strategic decisions.
The Bottom Line
While neobrokers offer significant benefits, they also introduce new financial literacy and behavioural and new investment practices that require careful consideration. Retail investors should be aware of these risks to make informed decisions and effectively navigate the evolving digital finance landscape to effectively leverage these cost-effective services to potentially build stronger portfolios than traditional, costly bank/packaged products, ultimately enhancing their financial well-being.
*This article is created as part of BETTER FINANCE’s social media educational campaign to make finance more accessible to Europeans. Check the original post on our LinkedIn page.
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