Ban PFOF or push for real-time settlement?

Rick Steves

PFOF is prohibited in several jurisdictions including the UK and Canada, but is a major revenue generator for retail trading platforms in the US. Robinhood alone made $196m from PFOF in Q4 2020, according to The Economist. 

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A survey conducted among senior executives from the global derivatives market found that almost half of the respondents (49%) backed a ban on payment for order flow in the US markets with 29% saying it should not be banned.

As the business operations of retail trading platforms have come under scrutiny in the wake of the GameStop trading craze, talks about the practice of Payment for Order Flow (PFOF) and its potential ban in the United States resurfaced.

PFOF is prohibited in several jurisdictions including the UK and Canada, but is a major revenue generator for retail trading platforms in the US. Robinhood alone made $196m from PFOF in Q4 2020, according to The Economist.

“Advocates of PFOF claim it has brought down costs for the retail investor and improved liquidity; critics that it distorts the market and hands too much power to a small number of trading firms. The Acuiti survey found that just under half of respondents (49%) called for PFOF to be banned with 29% saying it should not be and the rest unsure”, the report said.

As PFOF came into question with the meme stocks mania, especially with Robinhood getting all the attention, CEO Vlad Tenev has recently decided to go on a crusade against the two-day trade settlement period.

For Mr. Tenev, the problem is not the Payment for Order Flow model. Instead, the problem is when clearinghouses skyrocket deposit requirements overnight during times of extreme volatility.

In this scenario, investors are kept waiting for trades to clear, while clearing brokers are kept from their deposits until the settlement is finalized two days after the trade. These requirements can induce added risks. So, Mr. Tenev and others within the industry are calling for real-time settlement.

“Accomplishing this won’t be without its well-documented challenges, but it is the right thing to do and Robinhood is eager to drive this critical effort on behalf of all investors. Technology is the answer, not the oft-cited impediment. We believe it is important for all relevant stakeholders to convene in the near term to discuss the urgency and necessity of this issue”, Mr. Tenev added.

Several senior executives suggest increasing capital and margin requirements for retail platforms

Only 16% of senior executives said they thought that the increased trading activity by retail traders in certain stocks and derivatives instruments that hit international headlines posed a significant systemic threat to the wider market, the survey conducted by Acuiti found. 42% thought it posed a “slight threat”.

The respondents tend to believe the trading activity and communications on Reddit to encourage position taking was market abuse – 26% said it definitely did, 55% that it possibly did and 19% that it definitely did not. But most senior executives interviewed did not want regulators to take action and that the activity constituted a viable part of a free market.

Will Mitting, founder and managing director of Acuiti, said: “Greater scrutiny of the payment for order flow model might well be the lasting legacy of cacophony of commentary on the activities of certain retail traders in the US last month.”

Several respondents also suggested increasing capital and margin requirements for retail platforms to reduce any systemic risk in the market. Other measures proposed included better education of retail investors and limits on the leverage extended to retail investors.

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