Quick Downgrade For Discount Brokers in Light of SEC Comments

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As the SEC is considering changes to the little known “maker-taker” system, as first reported by ValueWalk, stock analysts have been quick to downgrade several brokerage firms.

The “maker-taker” system is one that permits brokerage firms to receive a cash payment for sending order flow to a particular stock trading platform.  If this fee were to be eliminated, discount brokerage firms, whose low fee offerings are largely funded through the rebate, would be most impacted.

Quick mathematical reaction in traditional market maker fashion

David Chiaverini at BMO capital markets was quick react. “We believe the crackdown on high frequency traders may also impact payment for order flow revenue, as order flow may be deemed less valuable if HFTs are unable to capitalize on it,” the bank said in a research note.

“We estimate TD Ameritrade Holding Corp. (NYSE:AMTD)’s (the fee revenue) represents 8% of revenue, E TRADE Financial Corporation (NASDAQ:ETFC)’s at 4%, and Schwab’s at 3%,” the research said, placing on display quick math skills that would make a traditional floor market maker proud.  “Assuming this revenue stream is very high margin business for the brokers, we estimate the elimination of this revenue would hypothetically negatively affect 2014 EPS by 17% for AMTD, 15% for ETFC, and 9% for SCHW ($27.90).”

Don’t expect quick changes

Considering what is likely a long and winding road filled with financial services lobbying, the research note stated what is painfully obvious to anyone who followed the Dodd-Frank rule making.  “Importantly, any regulatory or legislative change relating to the maker-taker system and HFTs may take time to play out and be implemented,” the note said, in what might be considered understatement.

Schwab emerging as outperform winner

Then the bank got down to the bottom line.  “We maintain our Market Perform ratings on TD Ameritrade Holding Corp. (NYSE:AMTD) and E TRADE Financial Corporation (NASDAQ:ETFC), and our Outperform rating on SCHW,” making straight talking Charles S. Schwab the early winner in what could result in a widespread disruption of the brokerage business model.  Schwab’s powerful stand on the issue has been said to boost the brand’s credibility and put a discount brokerage luminary at the central point in a debate.  As previously reported in ValueWalk, Schwab had called HFT a “cancer.”

As noted in the report, although Schwab is said to benefit from HFT rebates, the statement from an icon of average investors seems to disagree with HFT proponents. “If confidence erodes further, the fuel of our free-enterprise system, capital formation, is at risk,” the statement from Schwab read. “We can’t allow that to happen.”

On the day, Schwab was down 1.90%, E TRADE Financial Corporation (NASDAQ:ETFC) was down 6.48% and TD Ameritrade Holding Corp. (NYSE:AMTD) was down 5.32%.

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About the Author

Mark Melin
Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)valuewalk.com

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