The Fidelity-iShares agreement will involve the ETF issuer offering to compensate the broker for the cost of marketing the funds and the cost of the commission waivers. According to one ETF market observer I spoke to in London, iShares will effectively be paying Fidelity a form of trail commission for helping to distribute its funds.
Fidelity’s press release (now strangely missing from its site) pointed readers towards the iShares fund prospectus for further details of such fee-sharing arrangements, but the prospectus didn’t seem to offer me any clarification.
However, there are a couple of other areas where Fidelity could be making back some of the money it’s giving up. First, there could be some securities lending revenues available to the firm when clients’ ETF holdings are in Fidelity’s custody. Second, and perhaps more importantly, retail ETF users will still have to pay a bid-offer spread when making trades, whereas the broker can amalgamate and cross a lot of its trades internally using its “CrossStream” network, taking dealing spreads out of the equation. And, of course, “free” trades will encourage clients to transact more, generating more revenues for the broker.
All the same, this is another striking example of the cost reductions that ETFs and electronic trading platforms have combined to offer the average investor, which is nothing but good news.
Could similar changes be on the way in Europe too? In fact, as our recent survey of UK discount brokers showed, you can already buy ETFs for a notional £1.50 charge if you acquire them on a regular savings plan, although you lose the flexibility to choose the timing of your trades and use limit and stop orders.
Could online brokers in Europe go the whole way and remove trading commissions for all intraday trades on certain ETFs? According to one well-informed observer, we’re probably five years away from that happening, but Fidelity’s move (along with other recent fee-cutting exercises, such as db x-trackers’ move to charge a zero fee on its DJ Euro Stoxx 50 ETF last year) shows that competitive pressures are just as strong in Europe, too.
In fact, the same observer remarked that there are already agreements in place in Europe whereby the ETF provider rebates part of the management fee to institutional clients. The set-up of swap-based ETF providers in particular (where a bank owns the ETF provider and also has the institution as an equity trading client) makes it operationally easy for this to happen. That’s trail commission, in other words.
As competition for ETF investors increases, we can probably expect to see more and more creative ways of offering cheaper and cheaper access to the underlying market exposure. Investors won’t necessarily be getting the best deal unless they shop around, and there won’t automatically be a level playing field for all. But price wars look certain, regardless.