[HN Gopher] SEC Chairman Says Banning Payment for Order Flow Is ...
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SEC Chairman Says Banning Payment for Order Flow Is 'On the Table'
Author : pcbro141
Score : 26 points
Date : 2021-08-30 19:30 UTC (3 hours ago)
(HTM) web link (www.barrons.com)
(TXT) w3m dump (www.barrons.com)
| ab_testing wrote:
| That would be bad for the retail investor. PFOF tightens the
| spreads and increases speed of execution.
| missedthecue wrote:
| And subsidizes trading fees. Anyone else remember the days when
| the "cheap" brokers like ScottTrade would charge you $10 every
| time you bought or sold?
| masonium wrote:
| PFOF does not tighten "lit" spreads.
|
| PFOF does offer price improvement, which can effectively
| decrease the spread *for a particular marketable order".
| However, PFOF drives volume away from the limit markets, which
| determine the actual spread by which price improvement is
| measured against. So, it's a bit of a shell game.
|
| Concretely, at least 20% of all stock market volume is
| internalized in PFOF-style firms (citadel, virtu, et. al). If
| that volume were all on the lit exchanges instead, the spread
| on those exchanges would be narrower on average.
| gruez wrote:
| >>PFOF tightens the spreads and increases speed of execution.
|
| > PFOF does not tighten "lit" spreads.
|
| But that's fine right? This whole debate is about whether
| retail traders are being benefiting or losing (on net) from
| this. For the retail trader, the price improvement they get
| via PFOF is probably much better than the slightly better
| spreads they'll get on lit exchanges if PFOF was banned.
| jdsully wrote:
| If that were true the market makers would be losing money
| buying the order flow, and this conversation would be moot.
| But instead these firms are quite profitable doing this.
| It's a zero sum game so the money must come from somewhere.
| gruez wrote:
| >If that were true the market makers would be losing
| money buying the order flow
|
| No, because as other comments have mentioned, retail
| orders are generally "non-toxic" and "uninformed", which
| allows market makers to quote tighter spreads while still
| maintaining profit.
| jdsully wrote:
| Are we then saying the loser is the institutional
| traders? The money does not come from thin air.
| gruez wrote:
| Essentially, yes.
| pcbro141 wrote:
| Robinhood ($HOOD) down 8%
|
| ~75-80% of Robinhood's revenue is Payment For Order Flow.
| RosanaAnaDana wrote:
| That would be great for the individual investor.
| qeternity wrote:
| 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 wrote:
| 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 wrote:
| > off book
|
| What do you mean?
| slownews45 wrote:
| Sorry. To be more specific.
|
| Some of the orders can be internalized. Not sure how
| often this occurs:
|
| "The practice of internalization is prevalent in the
| Nasdaq market where Nasdaq market makers, who often pay
| for order flow or are sent order flow by an affiliate,
| trade proprietarily against incoming customer orders.
| NASD rules do not require Nasdaq dealers to expose their
| internalized orders to competitors."
|
| On the markets - since so much retail volume is off the
| market, yes, the market maker has to price improve, but
| it's against a less than full picture of the market for
| thinly traded items.
| gruez wrote:
| probably meant "not being routed to open exchanges".
| qeternity wrote:
| Yeah, just wanted to be clear. Off book means something
| else.
| [deleted]
| toomuchtodo wrote:
| 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.
| gruez wrote:
| >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 wrote:
| its the cost of investing, if that money is trouble for you
| then you shouldnt invest/trade anyway
| qeternity wrote:
| No, it's not, as PFOF has proven.
| gruez wrote:
| 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.
| qeternity wrote:
| > inherent conflicts of interest.
|
| Which conflicts would those be?
| [deleted]
| ffggvv wrote:
| 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 wrote:
| 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 wrote:
| laws are one thing, that doesnt eliminate the conflict of
| interest, it just regulates the ability to act on it.
| qeternity wrote:
| Uh, so if a conflict of interest exists (rife in all
| markets) and laws prevent exploitation...what's the
| issue?
| toomuchtodo wrote:
| 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
| -ac... (Control-F "gamification")
|
| 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
|
| 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 wrote:
| 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 wrote:
| 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.
| qeternity wrote:
| Yes, I said that within the context of this thread, which
| is PFOF...
|
| If you're arguing that there's a conflict of interest
| between Robinhood and its customers, then sure. But
| that's got nothing to do with PFOF.
|
| > Agree to disagree. We regulate smoking, alcohol,
| pharmaceuticals, gambling, and other behaviors that have
| self harm. This is no different.
|
| Sure, I never said no regulation. You gotta stop with the
| strawman attacks. We regulate these industries, as we
| ought to do with finance, but we nonetheless allow people
| to drink/smoke themselves to death or gamble themselves
| into oblivion.
|
| I'd rather live in a society where a small number people
| do enormous bad to themselves, over one where the state
| makes decisions for everyone.
| ctvo wrote:
| 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?
| qeternity wrote:
| 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.)
| ctvo wrote:
| Thank you for taking the time!
|
| > 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.
|
| Is this possible due to the technicalities in
| regulations? Since they're paying a better price, it's OK
| that they purchase the order from Robinhood and fill it
| themself? The order didn't hit the "open market" or
| whatever we'd consider it. It was filled before then, but
| the best price on the open market was less than what was
| filled for, regulators are happy.
|
| Very interesting that the money is from retail customers
| selling at bid, and makes sense.
|
| If you'd like to share -- what's front running in this
| scenario and how would MMs front run this, assuming it's
| legal.
| gruez wrote:
| >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/rob
| inh...
|
| The relevant 3 paragraphs start at "If the retail trades
| are random..."
| JumpCrisscross wrote:
| > _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]
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