January 19, 2022 PFOF Is Alive and Well in Europe Edward Monrad Optiver Follow | Profile | More Share Payment for order flow is not without its controversies, regardless of trading jurisdiction. In the U.S., market makers/wholesalers trade against the retail flow of affiliated brokers for a fee, either off-exchange (for stocks) or in on-exchange internalization models (for options). But just because this exact model isn't found in Europe, doesn’t mean it doesn’t exist, writes Edward Monrad, Head of European Equity Market Structure at Optiver Europe. On the contrary, Mr. Monrad argues that PFOF is alive and well in Europe. Here, he offers three models that hold the same potential for conflicts of interest that he sees in the U.S. Even for a topic that’s a lightning rod for controversy, payment for order flow (PFOF) has gotten an outsized amount of attention lately. After the GameStop drama, SEC Chair Gary Gensler announced that a PFOF ban in the U.S. was “on the table.” And amid the flurry of opinion pieces written in response, one Republican senator even introduced a bill that would prevent an outright PFOF ban. While there’s also been some debate about PFOF by politicians and regulators here in Europe, for most industry practitioners it’s not much of a concern. I guess there’s a pretty good reason for this: PFOF doesn’t really exist in Europe, at least not in the form that’s common in the U.S. As a quick review, in the American PFOF model, market makers make payments to brokers in exchange for the brokers routing retail orders to wholesalers who are affiliated with these market makers. The market makers/wholesalers are then able to trade against this retail flow, either off-exchange (for stocks) or in on-exchange internalization models (for options). But just because you don’t find this exact model in Europe doesn’t mean it doesn’t exist. On the contrary, I’d argue that PFOF is alive and well in Europe. Here are three models I’ve observed in various member states that hold the same potential for conflicts of interest that we see in the U.S. In the first scenario, retail brokers route their client orders to execution venues that operate single market maker models. A single market maker model is where there is only one designated liquidity provider for individual product classes. In many cases, the liquidity provider pays a fee to the broker in exchange for routing its client orders to the particular exchange where it’s the sole liquidity provider. A slightly different scenario occurs when brokers offer their customers a choice of where they’d like their order executed. In brokers’ marketing or client-facing interface though, preference is given to one particular venue, usually one that operates a single market maker model. Finally, I’ve seen practices where a third party covers clearing, trading or custody fees when brokers route their orders to them. This is in effect a cost discount that incentivizes brokers to send client orders to specific institutions for execution. All of these models raise issues very similar to those currently being debated in the U.S. If brokers route orders to execution venues where no genuine competition exists, are these brokers really delivering on their best execution obligations? And even if they are, do clients get the level of price improvement that genuine competition between multiple liquidity providers would provide? The European Commission has recently proposed to ban PFOF across member states, a move I support. However, I’m concerned that the current language in the proposals wouldn’t capture the practices described above as they are more narrowly focused on the American PFOF model. More expansive wording is needed to address the various models that exist across Europe. Greater awareness of the nuances of these practices is a start. As is further discussion about alternative market models that deliver the upsides of PFOF while still ensuring good competition for order flow. Stay tuned for more on that. This article,”PFOF Is Alive and Well in Europe,” first appeared on LinkedIn on Janurary 17, 2022.