More than half of Interactive Brokers' business now comes from RIAs, prop traders and hedge funds, making it the fifth-largest prime broker.
Interactive Brokers runs a low-cost automated brokerage with 3.5m accounts, earning $600 in commissions and $800 in net interest margin per account.
It grows organically because acquisitions would collapse a target's profits under its spreads.
How Interactive Brokers became the broker that compounds without advertising
Interactive Brokers is the most automated broker and the cheapest to serve. It earns from commissions and the interest on client cash and margin loans rather than from order flow, and its clients are experienced traders with large balances who trade often and borrow against their portfolios, so the account base compounds without advertising. Growth comes from taking share organically and from white-labelling the platform to RIAs, prop traders and hedge funds.
Takeaways
Commissions and interest spread carry the revenue. About 3.5m accounts trade roughly 200 times a year at around $3 a commission, about $600 per account and near $2bn across the base, plus about $800 each of net interest margin. Account growth of 25% a year is inflecting to 30-35%.
Automated liquidation lets it undercut rivals on margin. Accounts that miss a collateral call are liquidated by bot within minutes, so margin lending carries less risk and costs about half what Fidelity or Schwab charges, backed by roughly $18bn of excess capital.
Its clients are wealthier and trade far more. Average IBKR accounts hold $200,000 to a couple of million dollars and trade about 200 times a year, tens of times more than a Schwab or Fidelity account, against $5,000 to $10,000 balances at Robinhood or eToro.
Direct market access beats payment for order flow. IBKR routes orders to the market itself rather than selling them, and pays the local base rate less 50 basis points on large cash balances. Payment for order flow, largely a US practice, comes out of the customer's execution price.
It grows organically because acquisitions would fail. Applying IBKR's spreads and offering to a target would collapse that business's revenue and profits. Schwab's roughly 25m US accounts are the domestic yardstick. White-labelling for RIAs, prop traders and hedge funds is now over half the business, and IBKR ranks fifth among prime brokers.
Rate cuts and blowups are the chief risks. A 100 basis point fall in rates would cut net interest margin 10%. Archegos-style margin events and regulation of gambling-like retail trading are the other threats. The only significant loss came when the Swiss central bank let the franc appreciate, about 1% of capital.
How Peterffy built the brokerage
Thomas Peterffy was born in Hungary during the war and arrived in the US with nothing.
He bought a seat on the exchange and pioneered automated options pricing as Black-Scholes formulas appeared.
Timber Hill, his option market maker, made prices for decades and made risk management the firm's core discipline.
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On this episode 3
Show 1
When option market making stopped earning excess returns after the financial crisis, he closed it and put everything into the online brokerage.
Insiders still own about 80% of the stock, the bulk of it Peterffy's, in a company worth nearly $80bn.