May 26, 2021 UK FCA Targets U.S. Brokers Earning Payment for UK Clients’ Order Flow Rachel Wolcott Thomson Reuters Follow | Profile | More Lindsey Rogerson Thomson Reuters Follow | Profile | More Share Payment made to get retail order flow is permissible in the United States, but only if it is disclosed. In the UK, the chief regulator, the FCA deems it incompatible with the Markets in Financial Instruments Directive (MiFID II) rules on best execution, conflicts of interest and inducements. The FCA is reiterating through several statement that it doesn't want to see that practice begin for UK retail clients when US brokers are involved. This article by Senior Thomson Reuters Editors Rachel Wolcott and Lindsey Rogerson provides analysis on this issue. U.S.-based brokers have come under Financial Conduct Authority (FCA) scrutiny for routing UK customer trades to the United States for execution where the brokers receive payment for order flow (PFOF) from market makers, sources said. None has yet been subject to an announced enforcement action or final notice related to order routing and PFOF. The FCA will act against any broker receiving PFOF; its options include blocking or rescinding authorisation. “We have made clear through several statements that we consider PFOF as inconsistent with the MiFID II requirements on conflicts of interest, best execution and inducements, and as a result have restricted UK brokers from receiving PFOF. Within our jurisdiction, we will take action against any brokers who appear to be in breach of our requirements,” said a spokeswoman for the regulator, pointing to its 2019 multi-firm review on PFOF. “There is a lot of practice in the market which the FCA doesn’t like. The FCA has retail brokers, in particular U.S. retail brokers, who get funded by payment for order flow in their crosshairs. We know they’re looking at that,” said Tim Cant, a financial services partner at Ashurst in London. Order routing Payment for order flow is permissible in the United States, if it is disclosed. In the UK, the FCA deems it incompatible with the Markets in Financial Instruments Directive (MiFID II) rules on best execution, conflicts of interest and inducements. U.S. brokers operating in the UK disclose PFOF received for trades executed in the United States, however. The practice has grown in the United States among no-commission brokerages and trading platforms. Charles Schwab is one U.S. broker routing U.K. investors’ U.S. equity trades to the United States and attaching PFOF there. “All accounts are opened and held at CS&Co. This means you will be protected by best execution rules in the U.S. and not those in the U.K. CS&Co. receives payment for order flow for client orders it routes to U.S. liquidity providers and certain exchanges,” says the Schwab UK website. Interactive Brokers, another U.S.-based broker, also routes some trades to U.S. market makers and receives PFOF, according to its order routing and PFOF disclosure available on its website. The FCA said it is addressing U.S. retail brokers rerouting UK client trades to the United States and subjected to payment for order flow, by making clear through several statements that it considers PFOF as inconsistent with the MiFID II requirements and as a result has restricted UK brokers from receiving such payments. Both Schwab and Interactive Brokers have been subject to FCA fines unrelated to PFOF. Schwab was fined £8.96 million in 2020 for failing to adequately protect client assets, carrying out a regulated activity without permission and making a false statement to the regulator. Interactive was fined £1 million by the FCA in 2018 for market abuse systems and controls failures. Robinhood halted UK expansion Robinhood Financial, a high-profile U.S. no-commission trading platform which relies on the payment for order flow, a halted its UK expansion bid in 2020. The was due to the incompatibility of its PFOF business model and the FCA’s strong views on the matter, say officials familiar with the process. Robinhood has said, however, that the COVID-19 pandemic put its UK plans on hold ” indefinitely” after having gained broker authorisation from the FCA in 2019. In December 2020, the U.S. Securities and Exchange Commission (SEC) fined Robinhood $65 million for failing to inform customers about payments it received from trading firms to route customer orders through them — or PFOF. Between 2015 and late 2018, the SEC said, Robinhood made misleading statements and omissions on its website in response to customer questions about its largest revenue source. The firm has been subject to other regulatory fines. Zero-commission brokers The zero-commission app-trading sector attracted attention in January when retail investors flocked to Robinhood to buy shares in GameStop and AMC Entertainment Holdings. Questions about PFOF, zero-commission trading and market abuse came to the fore, prompting EU, UK and U.S. lawmakers to question the business models and practices of the upstart trading apps and no-commission firms. “Analysis of business models is a key part of how we assess the potential for harm for all firms,” a spokeswoman for the FCA said. Any statements or interventions the regulator makes related to zero-commission broker platforms “would be made public at the appropriate time” she said. “These lower costs for retail investors are a welcome development given the importance of costs in determining a long-term performance portfolio; however, there’s no such thing as a free lunch,” Steven Maijoor, former European Securities and Markets Authority (ESMA) chair told the European Parliament’s ECON committee in February. Several EU-based brokers were named during that ECON session as receiving PFOF, but Maijoor was clear such practice contravened MiFID II rules and promised ESMA would investigate. The FCA has banned five Cyprus-based brokers in the past 12 months for a variety of regulatory breaches including misselling banned contract-for-difference products to UK clients. Not all financial firms that previously passported into the UK under the European Union’s regime will be allowed to continue selling their services, Nikhil Rathi, FCA chief executive, said in a speech to the Association of Foreign Banks on May 6. Regulators need to sift through the 1,500 firms in the Temporary Permissions Regime, he said. “Cypriot brokers are coming in for a lot of scrutiny across the board, i.e., whether they’re conducting appropriateness tests, what their product governance is like and client comms. Those type of brokers and spread betters are coming in for a lot more scrutiny,” Cant said. This article first appeared in Thomson Reuters Regulatory Intelligence on May 25, 2021. Photo Credit: “UK money” by c_nilsen is licensed under CC BY-NC-SA 2.0 • • • Rachel Wolcott and Lindsey Rogerson are Senior Editors at Thomson Reuters.
Why are people against brokers selling orderflow? I don’t want mine sold so I use a broker that charges commission instead of selling my orderflow Everyone at the free commission brokers have the same option - just move your money Seriously, all the guys against selling of orderflow enjoy free commissions, it’s one or the other “If it’s free, you’re the product”
People are generally against PFOF because it appears it has widened out markets for everyone. I posted an academic study here a while back that comes to that conclusion. Payment is "considered" by many to just having increased the spread and most would prefer narrower spreads. So many assume it's just your money and markets as measured by average spread - have deteriorated. Price improvement in a wider market can be thought of as just rebating the now - over-generous spread. The challenge is trade thru and NBBO rules IMHO seem to prove it.
You overestimate the intelligence of the general population. Look at Robinhood, their PFOF terms were always disclosed but all customers ignored it until now. It took 5-6 years for people to pay any attention.
I trade UK options only and have noticed silly spreads for a few years now but the US is years ahead of the UK for retail trading platforms and market access..... or highly suspect!
PLenty of brokers do both. Sell the order flow and charge a commission. Schwab did it for like 10 years.