The issue of payment for order flow

Payment for order flow (PFOF) has become more and more widespread over the last years and has recently gained significant attention following the GameStop short squeeze in the US and related developments like the growth of discount brokerages. A PFOF arrangement is one in which a broker systematically routes its retail order flow to a single market maker, a systematic internaliser (SI) or other execution venue in return for a payment. PFOF is however detrimental for the investor as it may increase bid-ask spreads, distort competition, and make the price formation process less transparent and efficient.

Although the broker is obliged to act in the best interest of its clients, it has an economic incentive to direct order flow to the execution venue that offers the highest payment to the broker. Consequently, the best execution duty of the broker gets compromised. This conflict of interest is systematic in the retail market and FESE believes that it is currently not appropriately addressed. Whilst in some Member States PFOF is banned, such as in the Netherlands, other Member States are less strict. This creates regulatory arbitrage opportunities in the EU.

FESE calls for action to foster supervisory convergence in the EU: first, transparency around current market practices in Member States is needed. If regulators conclude that they have no means of proper oversight of these market practices, FESE recommends a policy change to bring supervisors into a position where they have access to information through stricter rules on broker information disclosures. Second, if the conclusion would be that requirements under the current regulation regarding best execution and conflicts of interest are not adhered to systematically, FESE suggests that regulators explore the possibility to change MiFID II/MiFIR and ban PFOF across the EU.