How is Michael Bolton supposed to live without… PFOF?

Mullet-clad, leather jacket toting 1980s soft rock crooner Michael Bolton sings about the heartbreak Payment For Order Flow (PFOF) can cause FX liquidity takers

Those of us old enough to be approaching adulthood in the late 1980s will no doubt remember the painful songs of heartrending soppiness by stonewash denim-wearing crooner Michael Bolton, as he sang about the demise of his latest disastrous romance whilst electric fans blew his permed mullet, resulting in him amassing a fortune as starry-eyed fans played his depressing tones ad nauseam.

What is perhaps rather less depressing and somewhat amusing is Michael Bolton’s approach to the limelight some 32 years after his first hit.

Gone is the mullet, gone are the drainpipe jeans and leather jacket, and perhaps best of all, gone is the endless whining about unrequited love.

All of these attributes have been replaced by a neatly trimmed gray hairstyle, sensible clothes and rather interestingly an interest in ensuring the democratization of electronic trading.

Former Tradable CEO Jannick Malling’s new and very popular Public project facilitated this by hiring Michael Bolton to revamp his 1989 hit “How Am I Supposed to Live Without You.” The new version is a lament about payment for order flow (PFOF), which was recently the subject of Reddit outrage and a point of inquiry in a House hearing.

According to The Verge, the Public is taking aim at Robinhood. After the uproar around Robinhood during the GameStop debacle, the Public announced it would no longer engage in payment for order flow. Last week, a day before Robinhood was quizzed about payment for order flow in a largely incoherent House subcommittee hearing, Public announced it had raised $220 million.

The very next day, politician Alexandria Ocasio-Cortez asked Robinhood CEO Vlad Tenev if he would commit to sending the proceeds from payment for order flow to his customers, a question he dodged.

To continue putting pressure on Robinhood, the Public is offering to cover any fees for transferring from moving from an existing brokerage.

This is a high profile attempt to draw attention to the unsustainability of PFOF in FX.

Making a market, which is often known as trade warehousing, or operating a ‘b-book’, is not illegal, and indeed Tier 1 banks and non-bank market makers are mainly engaged in making their own markets, largely due to their position being at the top of the chain.

What is poor practice is little understood by any regulatory authorities, and herein lies the loophole that has allowed a long and destructive chain of events to take place as a result of a handful of firms in the B2B sector of the FX industry which market their services to FX brokerages being able to prosper due to a case of marketing over substance?

Nobody should assume that any company with the word ‘prime’ in its title is by default offering prime Tier 1 liquidity.

At a conference a few years ago, FinanceFeeds asked a Chinese company where they were getting their liquidity from. The salesperson then proceeded to list a series of Tier 1 FX interbank dealers, but of course, it was clear that the company was a retail b-book MetaTrader broker, which sought to onboard other brokers and bucket the trades, which is a common practice in the region.

Unfortunately, it is the case that even today firms in regulated regions such as the United States and the United Kingdom still manage to get away with operating a company that markets itself as a prime of prime, yet engages in profit sharing, which is against the terms of an A-book license.

AFX Group, Fortress Prime and Boston Technologies are examples of companies that purported to offer a prime brokerage service, yet were profit sharing and b-booking. When the house of cards inevitably collapsed, brokers were left high and dry and could not pay their client withdrawals.

AFX Group brought down Gallant Capital, with which it had a profit-sharing agreement. FinanceFeeds investigated this at the time and gathered a vast amount of information over the past few years concerning the business activities of AFX Group, including its profit-sharing antics which were a massive contributing factor to the demise of Gallant Capital Markets, and a cause of many brokers who genuinely thought they had a prime of prime agreement with AFX Group being unable to withdraw their client funds.

Upon investigating the firm’s business four years ago, we were met with a barrage of calls from unrelated parties all over Cyprus, attempting to silence the publication of the facts, however, our research was absolutely right, as confirmed by a lawsuit in New York one year later by Esther Du Val, Chapter 11 Trustee for the estate of Gallant Capital Markets and Avenica.

AFX Group disappeared, and not much has been of consequence. The company’s external marketing man with an ego the size of a football stadium sent me a few angry messages threatening to ‘destroy my business’ if I carried on down the route of investigation, along with some colourful language. Charming.

Here we are in 2021, and unfortunately, profit sharing is alive and well.

FinanceFeeds has been made aware of an FCA registered firm offering exactly that. In its marketing, it says that retail brokers requirements are provided for in a one-stop-shop including liquidity for FX, commodities, technology and revenue share.

Revenue share is not allowed with a license that requires $125,000 of regulatory capital and stipulates that the broker must operate on an A-book agency execution basis, in other words, STP.

The STP model is definitely being debated, and many genuine prime of prime brokers consider it to be ‘broken’ and not fit for purpose in today’s market.

There has since been a twist in this situation, and many retail FX brokers are beginning to become aware of whether their prime of prime is b-booking them and are starting to look at taking their providers to task for not sticking to a 125,000 FCA license.

FinanceFeeds is now aware of a case of that which is being brought about by many brokers and may well end up in front of a judge. Nowadays this means that retail brokers expect and demand much more control over their order flow and how orders are executed, therefore they should be looking toward a multi-product solution that connects them to multiple sources of liquidity and multiple venues so that they cannot be beholden to one source of liquidity that can easily either slip them, warehouse their trades or sell their flow off for rebates.

Indeed, there are now solutions that ensure that this level of sustainability and control over a brokerage by its owners is possible, as demonstrated by the TraderEvolution Global platform which connects market participants directly to multiple sources of liquidity and executing venues, providing a genuine multi-asset solution.

Now, at a time during which traders are leading the way for the development of the entire industry via forums, TraderEvolution Global’s perspective is that should a brokerage company have an exchange membership on its domestic market and require a direct connection with that particular exchange for execution and market data, along with the international markets connected via some prime broker, and would like to offer all these markets within one single interface and market connectivity module, this is one of those that create an edge for the multi-market brokerage projects that are now a necessity for brokers to be able to be masters of their own destiny.

Last week, FinanceFeeds spoke to a prime of prime brokerage which said “If you are a British firm and you are operating under a 125,000 license, you are not allowed to do revenue shares, nor are you allowed to have “skin in the game”.”

To have “skin in the game” is to have incurred risk, monetary or otherwise, by being involved in achieving a goal. The main issues surrounding “skin” or excess “skin” is the principal-agent problem whereby transparency and fiduciary obligations are disregarded by principals who have the capital or excess capital (skin) tied into an entity.

It is entirely possible that lawsuits may ensue.

Whilst the efforts of the Public to show this in a humorous light may well be amusing, they make a very valid point indeed.

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