Back in 2021, the subreddit ‘r/WallStreetBets’ made news headlines as a huge spike in retail traders resulted in a coordinated short squeeze on GameStop shares taking place via forums on the social platform. The event created overnight millionaires and saw hedge funds like Melvin Capital lose billions of dollars in just a few months. In 2023, retail trading continued to surge, comprising approximately 23% of total trading volume during a peak week, demonstrating the enduring influence of retail investors beyond the ‘meme stock’ phenomenon. Mid-May 2024 the trend is reigniting. GME spiked 130%; AMC rallied 130% and BlackBerry rose over 23%. Despite all this movement, block trades remained light, with the price action arising from mostly retail sized 100-share orders. Younger, less experienced users are joining trading apps from their mobile phones in droves as brokers are left wondering whether they should cater this hungry emerging demographic. How are they more protected compared to typical investment clients? How can retail brokers properly support and service such clients while managing potential risks and ensuring that regulatory restrictions and requirements of regulatory bodies such as the FCA are adhered to? Would such retail customers fit every firm’s target market? 

According to a study by the London School of Economics, UK retail investors maintained a generally optimistic outlook on the financial markets in the beginning of 2024, despite broader economic concerns being raised by more seasoned and cautious institutional investors. This divergence in sentiment between retail investors and other market participants may stem from varying levels of information and understanding. Notably, 77% of retail traders expressed a neutral-to-optimistic view, compared to the broader caution seen in institutional sectors. The implication here is that retail investors may not be as deeply informed about the potential macroeconomic risks. Without the same level of understanding of the complex interrelated financial markets, retail investors are, on average, less capable of making consistently prosperous investment decisions. Studies show that as much as 90% of retail traders make a net loss over the course of their trading journeys. This discrepancy in performance is not being taken lightly by regulators, who are building increasingly stringent protections for retail traders that brokers should be wary not to violate. As regulations evolve, brokers must be especially cautious of how their communications and financial promotions could be perceived as taking advantage of this lack of trading knowledge or experience or the ‘fear of missing out’. 

Focusing on the UK as an example, the Financial Conduct Authority (FCA) introduced ‘Consumer Duty’ in July 2023 as the new regulatory standard; a significant shift for brokers who serve retail consumers. This new framework mandates a higher standard of care, compelling firms to actively ensure good outcomes for their retail consumers. Brokers are now obligated to proactively support their clients’ financial objectives with appropriate products and services, looking at price and value assessments and measuring consumer understanding and support. The FCA has made it clear that this is not merely about compliance, but about a fundamental change in corporate culture. The FCA has emphasized that the Duty will lead to a higher level of consumer protection in retail financial markets, where firms are consistently delivering good outcomes for consumers. This directive requires brokers to provide clear, understandable, and non-misleading information, ensuring that retail investors are well-equipped to make informed decisions. Sheldon Mills, the FCA’s Executive Director of Consumers and Competition, has also spoken about the impact of Consumer Duty. He has emphasized that the Duty is designed to raise the standards in how firms serve their customers, ensuring that financial products and services are fair, have clear charges, and offer value to the consumers. With the Duty being enforced for almost one year, since 31 July 2023, financial institutions should treat it as BAU and realize that the responsibility to adhere to these principles lies squarely with them, who must do their utmost to comply.  

To ensure compliance with the FCA’s Consumer Duty and to avoid any regulatory repercussions, brokers and financial services firms must and should have already adopted a comprehensive approach that spans several key areas as outlined by the FCA. Firms are encouraged to foster a culture that prioritizes customer outcomes, which should permeate throughout the organization from the top management to operational levels. Responsibilities for ensuring good customer outcomes should be well understood and actively managed across all business segments, not confined within risk and compliance departments. Firms need to leverage data more effectively, using it to actively monitor customer outcomes and ensure these align with the Duty’s expectations. This proactive engagement requires continuous oversight from management and boards, who should regularly review insights derived from data to preempt and address potential consumer harm before it escalates. Support for consumers, particularly those in vulnerable circumstances, must be thoroughly integrated into product design and customer service processes. Communication strategies should be clear, accessible, and designed to facilitate informed decisions. For vulnerable consumers, tailored communication and specialized support mechanisms are vital to ensure their needs are met and they receive outcomes as good as other consumers.  

Products and services must be carefully designed with a clear understanding of the target market, continuously assessed to confirm their appropriateness and fit. Firms must also evaluate whether the total costs borne by consumers—including fees and other charges—provide fair value, justified by the benefits offered. This involves ensuring transparency and effective communication within the distribution chain to align all parties with the Duty’s expectations for fair value and customer-centric outcomes. Improving data integration and information sharing across different functions within the firm can also lead to better anticipation of issues and more robust prevention strategies. A proactive and informed engagement at the board level regarding the practical and cultural implications of the Duty is crucial. Moving away from a reactive compliance mindset to proactive strategies that enhance customer welfare will not only help firms avoid penalties but also enhance their service quality, fostering greater consumer trust and satisfaction which, in turn, can drive competitive advantage in the market.  

As a warning to retail brokers, it is imperative to recognize that these responsibilities are not optional and are already enforced. The introduction of Consumer Duty is aimed at preventing harm and ensuring that financial products and services are appropriately designed and targeted. Failure to adapt to these changes could result not only in regulatory repercussions but also in diminished consumer trust and loss of business. By now brokers would have already reassessed their operational and strategic decisions to align with the Duty, and these principles would form part of their ongoing management discussions. While this new demographic of customers does present an opportunity to brokers, they must take care in how they choose to approach it to avoid severe repercussions. Check out the latest entry of the Finalto Broker Series to read more about regulations and potential implications to business and marketing initiatives, available HERE.

Reference:

The New GameStop Millionaires: Meet The Amateur Traders Who Won Investing’s Craziest Sweepstakes Ever (forbes.com)

The Power Of The Retail Investor (forbes.com)

Markets Are in The Doldrums but Retail Investors – 12:08:05 26 Jan 2024 – News article | London Stock Exchange

New Research: Success is limited until DIY investors break bad habits – Financial Times – Partner Content by Capital.com (ft.com)

90% Retail Investors Lose Money – Rediff.com Get Ahead

More Time To Trade Isn’t a Good Thing for Many Retail Investors | Stanford Graduate School of Business

Retail investors lose big in options markets, research shows | MIT Sloan

Zachariah Walker

Content Writer at Finalto

All opinions, news, research, analysis, prices or other information is provided as general market commentary and not as investment advice and all potential results discussed are not guaranteed to be achieved. The information may have been derived from publicly available sources, company reports, personal research, or surveys. Past performance is not indicative of future performance. Trading carries risk of capital loss. Service available to professional clients only.