5 ms·

SEC Chairman Says Banning Payment for Order Flow Is ‘On the Table’

29 points by pcbro141 5y ago

deleted 5y ago
[deleted]
toomuchtodo 5y ago
This is already banned in the UK, Canada, and Australia. I'm unsure why its taken so long to ban in the US considering the inherent conflicts of interest.
- qeternity 5y ago
  > inherent conflicts of interest. Which conflicts would those be?
  - ffggvv 5y ago
    Their duty should be to get the robinhood user the best execution price for their trade. But they make no money from the robinhood user, since there is no commission. Instead, they get paid by the market maker whose interests are to get the worst execution price possible for the robinhood user.
    - qeternity 5y ago
      By law, Reg NMS guarantees NBBO execution. Internalizers are providing price improvement vs. dumping an order on a lit exchange. So by definition, the “worst price” would be routing via SIP and execution against NBBO.
      - ffggvv 5y ago
        laws are one thing, that doesnt eliminate the conflict of interest, it just regulates the ability to act on it.
        qeternity 5y ago
        Uh, so if a conflict of interest exists (rife in all markets) and laws prevent exploitation…what’s the issue?
        toomuchtodo 5y ago
        The issue is PFOF is used by Robinhood to subsidize unsophisticated investors trading more to their own financial detriment. https://www.bloomberg.com/opinion/articles/2021-08-30/esg-accounting-requires-accountants https://www.bloomberg.com/opinion/articles/2021-08-30/esg-ac... (Control-F “gamification”) https://www.sec.gov/news/press-release/2021-167 https://www.sec.gov/news/press-release/2021-167 (SEC Requests Information and Comment on Broker-Dealer and Investment Adviser Digital Engagement Practices, Related Tools and Methods, and Regulatory Considerations and Potential Approaches; Information and Comments on Investment Adviser Use of Technology) https://www.sec.gov/rules/other/2021/34-92766.pdf https://www.sec.gov/rules/other/2021/34-92766.pdf It’s really no different then incentives and financial mechanisms casinos use to get folks in the door. Or, as the saying goes, “if you don’t know who is the sucker at the poker table, it’s you.”
        qeternity 5y ago
        You’re moving the goalposts. Whether or not Robinhood gamifies trading, or encourages gambling, has absolutely nothing to do with PFOF. Ultimately people should be able to do with their money as they please, include gambling it away on risky options trades. Bad trading is naturally self correcting.
        toomuchtodo 5y ago
        You asked me what the inherent conflict of interest is top of thread. I stated it. The goal posts are firmly where they started. Robinhood is getting paid to bring a product (the user) to market makers. If you’re not paying for the product you’re the product, all the jazz. > Ultimately people should be able to do with their money as they please, include gambling it away on risky options trades. Bad trading is naturally self correcting. Agree to disagree. We regulate smoking, alcohol, pharmaceuticals, gambling, and other behaviors that have self harm. This is no different.
      - ctvo 5y ago
        I'm ignorant of this space. Can you share how Robinhood and others make money through order flow? The semantics of it (an order has to receive the best price at the time of execution for example) doesn't capture the N ways a fund could make money here and still be compliant. Instead of worrying about the incorrect definitions used, can you share how firms benefit from order flow instead?
        gruez 5y ago
        >Instead of worrying about the incorrect definitions used, can you share how firms benefit from order flow instead? because there's a lower risk of being run over. https://www.bloomberg.com/opinion/articles/2021-02-05/robinhood-gamestop-saga-pressures-payment-for-order-flow https://www.bloomberg.com/opinion/articles/2021-02-05/robinh... The relevant 3 paragraphs start at "If the retail trades are random..."
        qeternity 5y ago
        The exact mechanisms by which MMs monetize order flow is the strictly guarded secret sauce. But largely it’s because retail order flow is uninformed, versus institutional order flow (bank, hedge fund, etc) which might be “toxic”. Here’s an example with ridiculously huge spreads but just to help illustrate the issue (in reality, the spreads are fractions of a cent): let’s say the market for AAPL shares is 150 vs 151. A retail trader market sells 100 shares. Absent a dark pool or other internalizer, they will end up hitting the 150 bid. A market maker knows there is a buyer for AAPL shares and expects the 151 offer to trade. The market maker (MM) pays 10c to Robinhood for the order, and buys the shares at 10c better @ 150.10. The MM has paid 150.20 effectively (151.10 + 0.10) when the next best buyer in the market was 150.00. Why would they pay a 20c premium? Because of the buyer I mentioned earlier that the MM believes will buy their shares. The MM turns around and offers these 100 shares for 150.90 (which is 10c better than the best current offer of 151.00) and a hedge fund immediately snaps those shares up. So what’s the net outcome? In this case, the trader has gotten a better price, Robinhood has received revenue and can offer their service for free, the MM has made a 70c turn on the trade (150.90 - 150.20) and the hedge fund buyer got a 10c better price than was available to them in the first place. Win, win, win, win. (The real issue is that Robinhood forces market orders which make retail traders consumer of liquidity and makes all of this possible. But that’s a different issue and PFOF is not the bad guy.)
  - deleted 5y ago
    [deleted]
- gruez 5y ago
  >This is already banned in the UK, Canada, and Australia And they're paying $5-10 in trading commissions per trade. For the typical retail trader whose order size is in the tens of shares, it's unclear how they're being harmed more than they're benefiting from it (from the free trading fees).
  - kwere 5y ago
    its the cost of investing, if that money is trouble for you then you shouldnt invest/trade anyway
    - qeternity 5y ago
      No, it’s not, as PFOF has proven.
    - gruez 5y ago
      Not sure about you, but given the choice between "$5/trade but it's the best price" and "free trades you might be losing a fraction of a cent per share", I'd take the latter.
      - jfengel 5y ago
        Given that trades are often in the thousands of shares, they sound like they're about on par to me. The main difference sounds psychological: "free" trades (with an asterisk) sound like they're designed to encourage people to trade quickly and without much thought. Which can be expensive come tax time, and doesn't encourage the kind of informed feedback that is supposed to keep markets honest.
ab_testing 5y ago
That would be bad for the retail investor. PFOF tightens the spreads and increases speed of execution.
- missedthecue 5y ago
  And subsidizes trading fees. Anyone else remember the days when the "cheap" brokers like ScottTrade would charge you $10 every time you bought or sold?
- masonium 5y ago
  PFOF does not tighten "lit" spreads. PFOF does offer price improvement, which can effectively decrease the spread *for a particular marketable order". However, PFOF drives volume away from the limit markets, which determine the actual spread by which price improvement is measured against. So, it's a bit of a shell game. Concretely, at least 20% of all stock market volume is internalized in PFOF-style firms (citadel, virtu, et. al). If that volume were all on the lit exchanges instead, the spread on those exchanges would be narrower on average.
  - gruez 5y ago
    >>PFOF tightens the spreads and increases speed of execution. > PFOF does not tighten "lit" spreads. But that's fine right? This whole debate is about whether retail traders are being benefiting or losing (on net) from this. For the retail trader, the price improvement they get via PFOF is probably much better than the slightly better spreads they'll get on lit exchanges if PFOF was banned.
    - jdsully 5y ago
      If that were true the market makers would be losing money buying the order flow, and this conversation would be moot. But instead these firms are quite profitable doing this. It’s a zero sum game so the money must come from somewhere.
      - gruez 5y ago
pcbro141 5y ago
Robinhood ($HOOD) down 8% ~75-80% of Robinhood's revenue is Payment For Order Flow.
RosanaAnaDana 5y ago
That would be great for the individual investor.
- qeternity 5y ago
  PFOF (more broadly, HFT + maker taker) has tightened retail spreads on both underlying AND options to levels previously unfathomable. I don’t get why people think retail are the ones getting ripped off. Retail order flow is uninformed. It’s profitable for that reason, and nothing nefarious. Institutional traders are the ones hurt by all of this. HFT latency arbing every single sniff you put out, front running every fill. PFOF has removed the uninformed order flow for hedge funds to trade against so they’re left trading against each other, or getting their lunch eaten by the aforementioned HFT.
  - slownews45 5y ago
    Exactly. Basically they took the money being made by institutions trading against individuals, and turned it into a check back to the brokerages. That said, I hate how much volume is handled off book with these pricing approaches so not a huge fan of it?
    - qeternity 5y ago
      > off book What do you mean?
      - gruez 5y ago
        probably meant "not being routed to open exchanges".
        qeternity 5y ago
        Yeah, just wanted to be clear. Off book means something else.
      - slownews45 5y ago
JumpCrisscross 5y ago
> He didn’t say whether the agency has found instances where the conflicts of interests resulted in harm to investors. SEC staff is reviewing the practice and could come out with proposals in the coming months. This is the key question. If we can't demonstrate harm, we have a theoretical problem weighing against billions of dollars in commission savings. If we can show harm, the question would be of the lightest-touch way to rectify that observed issue. Maybe it's banning PFOF, but I doubt it.
- deleted 5y ago
  [deleted]
kayman 5y ago
This has helped me form my view PFOF is not as bad as it sounds. https://a16z.com/2021/02/17/payment-for-order-flow/ https://a16z.com/2021/02/17/payment-for-order-flow/

29 points by pcbro141 5y ago

deleted 5y ago

[deleted]

This is already banned in the UK, Canada, and Australia. I'm unsure why its taken so long to ban in the US considering the inherent conflicts of interest.

qeternity 5y ago
> inherent conflicts of interest. Which conflicts would those be?
- ffggvv 5y ago
  Their duty should be to get the robinhood user the best execution price for their trade. But they make no money from the robinhood user, since there is no commission. Instead, they get paid by the market maker whose interests are to get the worst execution price possible for the robinhood user.
  - qeternity 5y ago
    By law, Reg NMS guarantees NBBO execution. Internalizers are providing price improvement vs. dumping an order on a lit exchange. So by definition, the “worst price” would be routing via SIP and execution against NBBO.
    - ffggvv 5y ago
      laws are one thing, that doesnt eliminate the conflict of interest, it just regulates the ability to act on it.
      - qeternity 5y ago
        Uh, so if a conflict of interest exists (rife in all markets) and laws prevent exploitation…what’s the issue?
        toomuchtodo 5y ago
        The issue is PFOF is used by Robinhood to subsidize unsophisticated investors trading more to their own financial detriment. https://www.bloomberg.com/opinion/articles/2021-08-30/esg-accounting-requires-accountants https://www.bloomberg.com/opinion/articles/2021-08-30/esg-ac... (Control-F “gamification”) https://www.sec.gov/news/press-release/2021-167 https://www.sec.gov/news/press-release/2021-167 (SEC Requests Information and Comment on Broker-Dealer and Investment Adviser Digital Engagement Practices, Related Tools and Methods, and Regulatory Considerations and Potential Approaches; Information and Comments on Investment Adviser Use of Technology) https://www.sec.gov/rules/other/2021/34-92766.pdf https://www.sec.gov/rules/other/2021/34-92766.pdf It’s really no different then incentives and financial mechanisms casinos use to get folks in the door. Or, as the saying goes, “if you don’t know who is the sucker at the poker table, it’s you.”
        qeternity 5y ago
        You’re moving the goalposts. Whether or not Robinhood gamifies trading, or encourages gambling, has absolutely nothing to do with PFOF. Ultimately people should be able to do with their money as they please, include gambling it away on risky options trades. Bad trading is naturally self correcting.
        toomuchtodo 5y ago
        You asked me what the inherent conflict of interest is top of thread. I stated it. The goal posts are firmly where they started. Robinhood is getting paid to bring a product (the user) to market makers. If you’re not paying for the product you’re the product, all the jazz. > Ultimately people should be able to do with their money as they please, include gambling it away on risky options trades. Bad trading is naturally self correcting. Agree to disagree. We regulate smoking, alcohol, pharmaceuticals, gambling, and other behaviors that have self harm. This is no different.
    - ctvo 5y ago
      I'm ignorant of this space. Can you share how Robinhood and others make money through order flow? The semantics of it (an order has to receive the best price at the time of execution for example) doesn't capture the N ways a fund could make money here and still be compliant. Instead of worrying about the incorrect definitions used, can you share how firms benefit from order flow instead?
      - gruez 5y ago
        >Instead of worrying about the incorrect definitions used, can you share how firms benefit from order flow instead? because there's a lower risk of being run over. https://www.bloomberg.com/opinion/articles/2021-02-05/robinhood-gamestop-saga-pressures-payment-for-order-flow https://www.bloomberg.com/opinion/articles/2021-02-05/robinh... The relevant 3 paragraphs start at "If the retail trades are random..."
      - qeternity 5y ago
        The exact mechanisms by which MMs monetize order flow is the strictly guarded secret sauce. But largely it’s because retail order flow is uninformed, versus institutional order flow (bank, hedge fund, etc) which might be “toxic”. Here’s an example with ridiculously huge spreads but just to help illustrate the issue (in reality, the spreads are fractions of a cent): let’s say the market for AAPL shares is 150 vs 151. A retail trader market sells 100 shares. Absent a dark pool or other internalizer, they will end up hitting the 150 bid. A market maker knows there is a buyer for AAPL shares and expects the 151 offer to trade. The market maker (MM) pays 10c to Robinhood for the order, and buys the shares at 10c better @ 150.10. The MM has paid 150.20 effectively (151.10 + 0.10) when the next best buyer in the market was 150.00. Why would they pay a 20c premium? Because of the buyer I mentioned earlier that the MM believes will buy their shares. The MM turns around and offers these 100 shares for 150.90 (which is 10c better than the best current offer of 151.00) and a hedge fund immediately snaps those shares up. So what’s the net outcome? In this case, the trader has gotten a better price, Robinhood has received revenue and can offer their service for free, the MM has made a 70c turn on the trade (150.90 - 150.20) and the hedge fund buyer got a 10c better price than was available to them in the first place. Win, win, win, win. (The real issue is that Robinhood forces market orders which make retail traders consumer of liquidity and makes all of this possible. But that’s a different issue and PFOF is not the bad guy.)
- deleted 5y ago
  [deleted]
gruez 5y ago
>This is already banned in the UK, Canada, and Australia And they're paying $5-10 in trading commissions per trade. For the typical retail trader whose order size is in the tens of shares, it's unclear how they're being harmed more than they're benefiting from it (from the free trading fees).
- kwere 5y ago
  its the cost of investing, if that money is trouble for you then you shouldnt invest/trade anyway
  - qeternity 5y ago
    No, it’s not, as PFOF has proven.
  - gruez 5y ago
    Not sure about you, but given the choice between "$5/trade but it's the best price" and "free trades you might be losing a fraction of a cent per share", I'd take the latter.
    - jfengel 5y ago
      Given that trades are often in the thousands of shares, they sound like they're about on par to me. The main difference sounds psychological: "free" trades (with an asterisk) sound like they're designed to encourage people to trade quickly and without much thought. Which can be expensive come tax time, and doesn't encourage the kind of informed feedback that is supposed to keep markets honest.

ab_testing 5y ago

That would be bad for the retail investor. PFOF tightens the spreads and increases speed of execution.

missedthecue 5y ago
And subsidizes trading fees. Anyone else remember the days when the "cheap" brokers like ScottTrade would charge you $10 every time you bought or sold?
masonium 5y ago
PFOF does not tighten "lit" spreads. PFOF does offer price improvement, which can effectively decrease the spread *for a particular marketable order". However, PFOF drives volume away from the limit markets, which determine the actual spread by which price improvement is measured against. So, it's a bit of a shell game. Concretely, at least 20% of all stock market volume is internalized in PFOF-style firms (citadel, virtu, et. al). If that volume were all on the lit exchanges instead, the spread on those exchanges would be narrower on average.
- gruez 5y ago
  >>PFOF tightens the spreads and increases speed of execution. > PFOF does not tighten "lit" spreads. But that's fine right? This whole debate is about whether retail traders are being benefiting or losing (on net) from this. For the retail trader, the price improvement they get via PFOF is probably much better than the slightly better spreads they'll get on lit exchanges if PFOF was banned.
  - jdsully 5y ago
    If that were true the market makers would be losing money buying the order flow, and this conversation would be moot. But instead these firms are quite profitable doing this. It’s a zero sum game so the money must come from somewhere.
    - gruez 5y ago

pcbro141 5y ago

Robinhood ($HOOD) down 8% ~75-80% of Robinhood's revenue is Payment For Order Flow.

RosanaAnaDana 5y ago

That would be great for the individual investor.

qeternity 5y ago
PFOF (more broadly, HFT + maker taker) has tightened retail spreads on both underlying AND options to levels previously unfathomable. I don’t get why people think retail are the ones getting ripped off. Retail order flow is uninformed. It’s profitable for that reason, and nothing nefarious. Institutional traders are the ones hurt by all of this. HFT latency arbing every single sniff you put out, front running every fill. PFOF has removed the uninformed order flow for hedge funds to trade against so they’re left trading against each other, or getting their lunch eaten by the aforementioned HFT.
- slownews45 5y ago
  Exactly. Basically they took the money being made by institutions trading against individuals, and turned it into a check back to the brokerages. That said, I hate how much volume is handled off book with these pricing approaches so not a huge fan of it?
  - qeternity 5y ago
    > off book What do you mean?
    - gruez 5y ago
      probably meant "not being routed to open exchanges".
      - qeternity 5y ago
        Yeah, just wanted to be clear. Off book means something else.
    - slownews45 5y ago

JumpCrisscross 5y ago

> He didn’t say whether the agency has found instances where the conflicts of interests resulted in harm to investors. SEC staff is reviewing the practice and could come out with proposals in the coming months. This is the key question. If we can't demonstrate harm, we have a theoretical problem weighing against billions of dollars in commission savings. If we can show harm, the question would be of the lightest-touch way to rectify that observed issue. Maybe it's banning PFOF, but I doubt it.

deleted 5y ago
[deleted]

kayman 5y ago

This has helped me form my view PFOF is not as bad as it sounds. https://a16z.com/2021/02/17/payment-for-order-flow/ https://a16z.com/2021/02/17/payment-for-order-flow/