The SEC, Market Makers, and Order Flow Payment – 24/7 Wall St.
About a year ago, after stock trading erupted during the stock craze, new U.S. Security and Exchanges (SEC) Chairman Gary Gensler waded into controversy over a practice called payment for order flow (PFOF), which involves market makers (also called wholesalers) like Citadel, Susquehanna, and Virtu paying brokerages to execute exchange trades on behalf of brokers.
This is a lucrative business for the biggest PFOF brokerages. TD Ameritrade received $994 million in PFOF revenue for 2020 and 2021, by far the most of any brokerage. Robinhood placed second with $532 million, while E*Trade placed third with $316 million, Schwab finished fourth with $222 million, and WeBull closed the top five with $118 million. payments received.
The data was collected by BrokerChooser’s Adam Nasli and released earlier this month. Nasli reviewed SEC 606 reports from 12 brokers to compile the data. Two of the brokers on its list, Fidelity and Vanguard, received no PFOF income for both years. Including the top five, the top 10 brokers received $2.27 billion in payments for order flow for the two years.
Among market makers, Citadel paid the most to brokers, $2.6 billion, or nearly 40% of all PFOFs to brokers over the two-year period. Susquehanna (G1X and Global Execution Brokers) paid $1.5 billion (22% of total), Virtu paid $644 million (10%), Wolverine paid $628 million (9%), Two Sigma paid paid $205 million (3%) and Jane Street Capital paid $61 million (1%). These six companies accounted for approximately 84% of all order flow payments to brokers.
Last month, SEC Chairman Gensler said the agency was considering rule changes that would increase competition for trading orders and improve prices for retail investors. Robinhood derives around 75% of its revenue from PFOF, and it is in the company’s interest to have many orders from investors that market makers are willing to pay.
The SEC wants to know if brokers send PFOF orders to market makers that offer the largest payout to the brokers rather than to the exchange that offers the best price (known as NBBO, National Best Bid and Offer) for the investor .
“Best Execution” rules require retail brokers to send client orders to the venue offering the best price, or better price. Market makers usually make an offer that is a fraction of a penny better than the best price. Because exchanges like the New York Stock Exchange and Nasdaq cannot offer quotes below one cent, exchanges lose market to market makers.
Last May, BestEx Research published a report on the good, the bad and the ugly of PFOF. According to the report, market makers (or wholesalers) can improve the NBBO to investors by 15%. Moving this retail flow out of obscurity to regulated exchanges would reduce the NBBO spread by 25%. Here’s how the report’s authors, Hitesh Mittal and Kathryn Berkow, put it:
While superficially it may appear that retail investors are benefiting from routing their order flow to wholesalers, the reality is quite different, especially given the recent increase in total retail trading volume. Our estimate is that if retail moved to a public forum, the NBBO itself would drop significantly, eclipsing the 15% difference between what is currently available on exchanges and what wholesalers are offering in the form of enhancement. prices.
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Here’s a short video Gensler made last month summarizing the SEC’s current thinking on PFOF: