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| {{a|g|}}Oh lord, where to start. | | {{freeessay|disaster|Payment for order flow|{{image|GameStop Stop|png|}} }} |
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| Payment for order flow was a big deal in Europe for years, and the Americans — usually such fastidious over-regulators — have been strikingly blasé about it. Much of the American love of playing the markets depends on it, in fact. | |
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| All this was brought into sharp, public relief, in the great [[market un-crash]] of January 2021, when the massed armies of the investing public — for so long a huge, docile cow, tethered to the stall and irretrievably wired into the great [[financial services]] milking machine — woke up and decided to have things their way for once.
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| Said milking machine reacted rather petulantly. In the mean time a great awakening was happening. In a turn of events that is rather characterising the digital revolution, the denizens of Reddit discovered they were the ''product'', not the ''customer'', and the means of that transmission was [[payment for order flow]].
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| ===What is PFOF?===
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| The theory is — ought to be — when your order is filled you pay your broker a commission. Your broker has all kinds of regulatory obligations — the key ones are generally lumped together and called “[[best execution]]” — to make sure you get the best price available. This keeps the broker honest.
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| Okay. Now a broker fills your order by going to the market. In practice this means The broker will interrogate [[market maker|market makers]], [[Exchange|exchanges]] and other sources of market liquidity ([[Multilateral trading facility|multilateral trading facilities]] [[dark pool]]s and so on), to identify that best price, retrieve it and bring it back for you.
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| Note the inherent asymmetry here: on one side of the broker millions of tiny investors, each paying teeny commissions. On the other side, a small number of market intermediaries, each hoping to handle a vast volume of transactions, charging even teenier commissions, but in such colossal quantities that in aggregate it makes a ''lot'' of money.
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| The more “order flow” an [[market-maker]] gets, that is to say, the more money it makes.
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| Like brokers, market-makers are [[Agency problem|agents]]: they do not take a true principal position, but merely route customer orders to the market. Their revenue is an annuity: it depends on ''volume''. [[Market-makers]] will (if allowed happily pay “[[Retrocession|retrocessions]]” for volume to individual brokers. They pay, in other words, for order flow.
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| They are allowed to do that in the US; they are not in the UK. The FCA banned payment for order outright in 2012 on the theory that it undermines transparency and efficiency, is inimical to the idea of [[best execution]], and also it creates a perceived conflict of interest between broker and clients.
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| In the US the dynamic is very different. Payment for order flow allows the retail platforms (Ameritrade, Schwab, eToro, RobinHood etc) to offer ''commission free'' trading.
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| Like in Vegas, ''if the drinks are free, you are paying some other way''. Most retail folks are happy enough with that trade: brokers have to disclose their PFOF arrangements. Sunlight is the best disinfectant, right? But for the most part the [[conflict of interest]] is more optical than fundamental: neither the broker nor the market-maker has a dog in the fight: as long as the trade gets done, everyone gets their little [[Look, I tried|nibble on the client’s parcel]] and all is well in the world.
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| The [[GameStop]] [[market un-crash]] of 2021 has highlighted, starkly, that [[conflict of interest]] becomes a bit more visceral when it turns out the [[market maker]]’s ''brother'' has a dog in the fight. Some [[market-maker]]s are part of bigger [[financial services]] organisations, and may also have a [[broker-dealer]], an [[asset manager]] and even — [[dramatic look gopher]] —a [[hedge fund]] in the same market.
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| Now if the [[hedge fund]] is short a stock that retail markets are buying like crazy through the trading platform then — hold on tiger. If ''all'' the [[long]] interest is coming through the retail platform, and ''all'' the [[Short sale|short]] interest is institutional, then if the long activity on the platforms can be dampened somehow — you know, by the platform suddenly shutting down the ability for punters to put risk on, and only allowing them to take risk off — that makes the job of shorting the kahunas out of the market a lot easier.
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| {{sa}}
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| *[[GameStop]] and the great [[market un-crash]] of 2021
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| *[[Inducements]] and the rule against them.
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| *[[Conflict of interest]]
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| *The [[FCA]]’s [https://www.fca.org.uk/sites/default/files/marketwatch-51.pdf FCA Marketwatch 51] of 1 September 2016 should give you what you need. If that isn’t enough, have a look at the FCA’s original [https://www.fca.org.uk/publication/thematic-reviews/tr14-13.pdf Thematic Review TR 14/13] of [[best execution]] and [[PFOF]].
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