Adam Reynolds, CEO Asia Pacific, Saxo Capital Markets, is urging brokers and regulators to review the practice of Payment for Order Flow (PFOF).
Mr Reynolds says:
“As more people participate in global capital markets, brokers have a real duty of care to their clients and we believe that it is time for regulators in Asia and the brokerage industry to review such practices and collectively work towards protecting the interests of retail clients”.
Payment For Order Flow (PFOF) is the compensation a brokerage firm receives for directing orders to a particular venue for trade execution. The brokerage firm receives payment, usually fractions of a penny per share, as compensation for routing the order to a specific market maker.
The most common criticism of Payment For Order Flow is the fact that a broker is receiving fees from a third party without a client’s knowledge. Such payments incentivise the broker to route its orders to a particular venue, which naturally could be considered a conflict of interest. The broker may choose to send the order to the venue offering the highest payment to the broker rather than the best execution to the client.
Most recently, the European Commission has taken steps to follow the Australian Securities & Investments Commission (ASIC)’s position in banning the practice of Payment for Order Flow (PFOF), to circumvent the emergence of Payment For Order Flow arrangements. This is a critical move that is set to level the playing field for investors and bring more transparency, so that clients know they are not selling their flow to market makers.
For many low-cost brokers offering zero or low commissions on equity transactions, Payment For Order Flow is a major source of revenue. This practice could cause a conflict of interest between broker and client as the brokerage firm might be tempted to route orders to a particular market maker for their own benefit, rather than seeking a best execution price for the investor, their client.
Saxo notes that investors who trade infrequently or in small quantities may not feel the impact from this practice. However, frequent traders and those trading large volumes should aim to understand their broker’s order routing system to make sure that they’re not losing out on price improvement due to their broker prioritising PFOF.
“At Saxo, we do not use or receive Payment For Order Flow (PFOF). Saxo executes equity orders using smart order routing (SOR) technology, which sources liquidity from multiple venues, including regulated exchanges and MTFs, to optimise execution rates and fill ratios”.
SOR is an algorithm which automatically compares execution prices for any given buy or sell order. It avoids conflicts of interest by discovering best available prices and routing traders’ orders to the venue offering best execution independent of Payment For Order Flow.