Research

Although rising U.S. interest rates are making up part of the lost revenue, cutting costs “rarely lead to increased market share,” report finds

By James Langton |

Intensifying competition for retail clients is driving a costly price war among U.S online brokers, according to a new report from Moody's Investors Service Inc.

Specifically, gradually rising U.S. interest rates is increasing the value of retail clients' assets, which is, in turn, sparking a price war among U.S. online brokers to cut their equities trading commissions as they compete more aggressively for clients, which will pressure revenue, the Moody's report says.

Yet, the credit-rating agency warns that these kinds of tactics "rarely lead to increased market share, resulting in reduced earnings and cash flows for all players." In the short term, the positive impact of rising interest rates will mask the revenue hit from lower commissions.

For example, the Moody's report suggests that a 25-basis-point increase in the target federal funds rate should generate US$300 million to US$400 million of annual incremental revenue for online broker, Charles Schwab Corp. At the same time, the report projects that a recent cut in trading commission rates that Schwab has implemented will cost the firm US$300 million in revenue over the next 12 months.

"Any brokerage firm that does not gain significant client market share will be worse off from the price war," says David Fanger, senior vice president with Moody's, in a statement. "However, our analysis of the firms' disclosures shows that the boost to net interest revenue from rising short-term rates will mask the effect, though some fare better than others."