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  • Home
  • News
    Bets increase on a soft landing in the U.S

    Bets increase on a soft landing in the U.S

    69% of investors believe metaverse entertainment will change social lifestyles

    69% of investors believe metaverse entertainment will change social lifestyles

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    Europe prepares law to make airlines that pollute more pay higher costs

    Europe prepares law to make airlines that pollute more pay higher costs

    Why are Asian investors selling their tech stocks?

    Why are Asian investors selling their tech stocks?

    Here’s what the economy and markets will look in 2023, according to JP Morgan

    Here’s what the economy and markets will look in 2023, according to JP Morgan

    Are technology stocks coming to the end of their reign?

    Are technology stocks coming to the end of their reign?

    Amazon fined millions for manipulating algorithms in its favor

    Amazon fined millions for manipulating algorithms in its favor

  • Markets
    Bets increase on a soft landing in the U.S

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    What are CFDs and what are their advantages?

    Getting started with CFD trading

    Goldman Sachs lands with more strength at Santander and BBVA

    Goldman Sachs lands with more strength at Santander and BBVA

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    Should payment for order flow be maintained in the stock market?

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    Why are Asian investors selling their tech stocks?

    Here’s what the economy and markets will look in 2023, according to JP Morgan

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    Microsoft leads the ranking of the best-managed companies in 2022

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    Apple: consequences of the Foxconn conflict will continue until 2023

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    EU organized a party in the metaverse and nobody attended

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    Brazilian Congress approves bill to regulate cryptocurrencies

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INVESTOR TIMES
Home Markets

Should payment for order flow be maintained in the stock market?

Santiago Contreras by Santiago Contreras
12/15/2022 - 9:23
in Markets
Reading Time: 3 mins read
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The advantages and disadvantages of Payment For Order Flow (PFOF) have been the subject of debate for some years. This is the mechanism used by brokers to obtain income from the so-called alternative exchanges (hedge funds or MTFs). Brokers receive commissions from these companies for sending their clients’ orders to them instead of sending them directly to the main trading centers.

Before this type of exchange appeared, brokers obtained their income from the commissions offered by the clients themselves for a transaction. The market was limited to a smaller number of investors compared to today’s market. After the appearance of financial intermediaries and payments for order flow, more people could trade on the stock market.

Until Robinhood came along

The first in the United States to use this business model was Robinhood Markets Inc. The audacious broker revolutionized the market and popularized it by promoting a service without direct commissions for its clients. Free trading on the stock market was born, as investors do not pay commission to the broker but the broker benefits from the intermediation. Instead of charging the trader, he makes his profits from the commissions paid to him by the hedge fund.

One of the world’s largest funds is Citadel Securities, which is in dispute with the U.S. Securities and Exchange Commission (SEC). The regulator wants to reorganize the structure of the U.S. stock market. Its chairman Gary Gensler says investors are entitled to a better deal in stock trading.

His proposal is aimed at achieving greater competition for orders. These SEC concerns came after the frenzied episode with GameStop Corp. in early 2021 that sparked a convulsion on Wall Street. The video game retailer’s stock was artificially inflated by small traders manipulated by very creative players.

Profit sharing?

The Payment For Order Flow business is all about volume. For every customer order issued, Citadel earns mere pennies. The Miami-based market-making firm buys the shares and sells them to Robinhood’s clients. But on thousands of orders issued in its daily trades the profit is very high. For both Citadel and Robinhood.

Proponents of this system point out that small traders make better profits on the stock market. While its critics argue that this practice has contributed to distort the market making it impossible to calculate what the trader actually earns with his operations.

The debate on this point is no longer academic but legal. In the opinion of brokerage and trading firms, there is little evidence to confirm that the current system is harming investors. Robinhood and other firms are preparing to sue the SEC if Gensler’s proposed changes jeopardize business.

Market Concentration

During 2021, a dozen U.S. broker-dealers collected about $3.8 billion in order-flow payments, according to Bloomberg Intelligence research. Most of this money came from Citadel Securities, which paid brokerage firms about $1.5 billion.

“When you look at the kind of execution quality we’re getting, it’s really hard to say that order-flow payout is a problem,” says Jeff Starr, managing director of Charles Schwab Corp, TD Ameritrade’s parent company.

U.S. hedge fund giant Citadel Securities, has $59 billion in capital. This company alone handles more than 20% of the shares traded on the U.S. stock market on a daily basis.

Both Citadel Securities and its sister company, Citadel, belong to multimillionaire Ken Griffin. He is known for his fondness for works of art and the purchase of expensive real estate, as well as his financial support for the Republican Party to which he has donated more than $68 million to its campaigns. This week, Griffin filed a lawsuit against the Internal Revenue Service and the Treasury Department for damages, alleging tax privacy violations.

Citadel involved in GameStop case

In the wake of the GameStop controversy, Citadel Securities and Robinhood were at the center of criticism for their actions. Citadel denied any involvement in market manipulation. Griffin nonetheless came under serious questioning at a hearing held by the Democrat-dominated House Financial Services Committee.

Since that time, the firm has steered a little further away from the pay-for-order-flow debate and the SEC’s plans to regulate hedge fund performance in this area. Unlike other funds such as rival Virtu Financial Inc.

“Citadel is at a bit of a disadvantage because Ken is kind of a lightning rod right now politically,” noted Virtu CEO Douglas Cifu. Citadel Securities’ differences with the SEC have been discussed in other settings such as industry conferences and in closed-door meetings with regulators.

Since last year, Griffin has met with Gensler to discuss market structure. The firm has proposed a less radical set of changes from those the SEC plans to introduce, sources familiar with the matter revealed to The Wall Street Journal.

SEC proposes more competition

Gensler believes that greater competition among trading firms participating in the market would benefit investors because they would get better prices on their trades. The official, however, acknowledged that the SEC’s proposal could also de-improve the profits of brokers and trading firms.

“Putting people in competition is better for investors and issuers,” Gensler said. He added that “it could have a tendency to reduce some of the economic rents in the middle.”

Citadel Securities is waiting for the SEC to finalize its final proposal on the issue before launching a campaign against the proposed changes. So said Joseph Mecane, the chief executive of the company’s unit that processes transactions for retail brokerages.

“We’re quite proud of the expertise that has been developed for retail investors. Anything that, in our opinion, negatively impacts the retail experience would be something we would be concerned about,” Mecane said.

The trades the firm executes for individual investors is more lucrative for these types of firms. It is considered more profitable to fulfill orders issued by individuals than to negotiate commissions with large investors who participate in the stock market.

Citadel Securities, Virtu and all other trading firms in the industry make profits through market making. Their strategy is to capture the bid-ask spread of stock prices, i.e. supply and demand.

The small investor probably does not care much about how much these types of companies earn, as long as his access to the stock market is guaranteed and he does not have to pay direct commissions to the brokerage firms just to participate.

Tags: Citadel SecuritiesPayment by Order FlowRobinhood Markets Inc.United States Securities and Exchange Commission (SEC)

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