The European Parliament’s Economic Affairs Committee voted on Wednesday in favour of a draft law from the European Commission that seeks to ban payment for order flow (PFOF). The pro-ban vote clashes with the decision of EU member states to allow PFOF under specified strict conditions and in countries that chose to adopt it.
Therefore, the vote has pitted EU lawmakers with member states and both parties need to agree on a joint position that would become law, Reuters reports on Wednesday. The proposed ban is one of several draft laws targeted at updating the European Union’s Markets in Financial Instrument Directives II (MiFID II).
What’s with PFOF?
The payment for order flow is an amount paid by wholesale markets' participants such as market makers and hedge funds to retail brokers so that the latter can redirect some of their clients' orders to them, rather than to exchanges, for execution . The PFOF as a business model for retail brokers became popular through US broker Robinhood which disrupted the established brokerage industry by charging retail traders zero commission and instead generating its revenue from routing their orders to private market makers.
The practice has caught the eyes of several regulators including in the United Kingdom where it has been banned and in the United States and Australia where securities regulators are also considering a ban. In early 2021, Public.com, a zero-fee broker, announced that it would no longer route orders to market markers but instead send them directly to exchanges for trade execution.
Other Propositions of the EU Draft Law
Apart from the ban on PFOF, another provision of the draft law seeks to introduce 'consolidated tapes' to provide near real-time prices of stock and bonds. The goal, Reuters reports, is to aid traders in securing the best deals being offered by multiple platforms that trade the same shares in Europe.
However, exchanges are against this development as they profit from selling their market data. Instead, they prefer a tape that displays prices of already completed trades.
US SEC Proposes Amendment to PFOF Rules
In December 2022, the United States Securities and Exchange Commission (SEC) proposed some amendments to its PFOF rules as it believes that the practice promotes a lack of competition in the market, costing customers $1.5 billion annually. However, Adam Nasli, the Head Analyst at BrokerChooser, says the securities regulator’s estimation “seems high and difficult to believe.”
One of the remedial actions being proposed by the SEC is that certain customer orders should be routed into an open auction where execution providers would compete. The regulator believes this will promote competition and help investors secure the best prices.
However, Nasli explained that retail brokers that get most of their revenue from the PFOF model will be forced to revisit their business model should the proposals be implemented without further adjustments. “Some may even go as far as reintroducing commissions,” Nasli explained in his commentary on the SEC’s proposal.
