Why the Future of Online Trading and Banking Is More Scale

Charges for client services pale by comparison with the opportunities to collect their money and make more money off of it. Which means that - as in most tech businesses - access to greater asset volume (whether cash, attention or both) is the most profitable strategy. JL 

Telis Demos reports in the Wall Street Journal:

There is potential to combine the back-end plumbing in their business to control the cost of trade execution and settlement when they mostly give it away free. More scale in the retail trading business also provides leverage when selling order flow to wholesale brokers and when making shares available for borrowing. These are important ways of making money from trading. In banking, the zero-commission is now at the heart of this business. To distribute customer cash and earn a net interest margin on that cash could be more lucrative
First beat your rivals up on price, and then buy one. If that is how things play out for Charles Schwab, investors could stand to gain.

Charles Schwab is in talks to buy rival TD Ameritrade, which would create a giant retail brokerage and asset management business. After slashing trading commissions to zero in quick succession in October, the two companies’ stocks might be down, but the rationale for combining—a long-speculated outcome—is stronger than ever.
Most obviously, there is potential to combine the back-end plumbing in their business. Anything to control the cost of trade execution and settlement when they mostly give it away free is welcome. More scale in the retail trading business also provides leverage when selling order flow to wholesale brokers and when making shares available for borrowing. These are important ways of still making money from trading.
Then there is the banking side, which in the zero-commission era is now at the heart of this business. A key question is what will happen with Ameritrade AMTD -0.29% customers’ cash. Schwab has long operated its own bank. Ameritrade partners with Toronto-Dominion Bank (a roughly 40% owner of the company) and others to distribute customer cash and earn what is, in effect, a net interest margin on that cash. Schwab currently generates a higher net interest margin than Ameritrade, so in theory that same customer cash could be more lucrative if deposited at Schwab’s bank.
Schwab and Ameritrade together would also have an enviable position beyond self-directed trading in wealth management. The combined platform for custodying independent adviser assets would be by far the largest. And combining the companies’ marketing efforts in robo-advisory and other products for younger investors could create an industry heavyweight.
What could temper investors’ enthusiasm would be price. Ameritrade’s shares traded off 26% when Schwab first announced on Oct. 1 it was doing away with commissions. After popping on Thurdsay’s news, the stock has now clawed all that back. Still, a combination might be the best way to extract value from a commissionless business.
The spotlight will also now fall on the next biggest player in online discount broking, E*Trade Financial, which closed down 9% on its rivals’ news. Concerned investors apparently don’t want to see anybody dancing alone.