The brokerage industry is exploring alternatives to payment for order flow with SEC President Gary Gensler targeting the practice.
CNBC has learned that the idea comes from Apex Clearing. The clearinghouse handles transactions for SoFi, Webull, and other fintech companies and has quietly built a marketplace to match customer orders. The “auction” process, as the CEO of Apex describes it, could allow exchanges to compete directly with market makers such as Citadel Securities and Virtu.
“It creates more competition, which will translate into better prices,” Apex CEO Bill Capozi told CNBC. The big winner is the retail investor. “
Earlier this week, SEC Chairman Gary Gensler proposed changing the rules that govern how Wall Street handles retail transactions. The largest securities regulator said its plan would partly force companies to compete directly to execute trades for retail investors. Gensler is also looking for more disclosures regarding fees and data. The head of the Securities and Exchange Commission criticized the possibility of conflict of interest and complained about the concentration of power among some market makers.
“I asked employees to take a comprehensive, multi-market view of how we can update our rules and make our stock markets more efficient, especially for retail investors,” Gensler said at the Piper Sandler FinTech Conference on Wednesday.
Payment for Order Flow, or PFOF, refers to the payments that brokerages receive to route clients’ trades to a market maker, such as Citadel Securities or Virtu. Although often a fraction of a penny, this arrangement generates the bulk of revenue for Robinhood and other brokerages, and has allowed them to offer commission-free trades.
PFOF is widely practiced by the brokerage industry but has been criticized during the Gamestop saga. Gensler and the Securities and Exchange Commission questioned the potential conflicts of interest and whether retailers were getting the best prices. Companies really have to offer customers the best rates, known as “best execution.”
Apex’s Capuzzi said that while the market – which is technically called an alternative trading system – is “built and ready to go,” it has not yet launched and may require SEC approval. But if approved, such an auction could preemptively resolve some of the agency’s complaints about the business of the securities industry behind the scenes.
There may be more examples of companies trying to test ideas before any official rulings from the Securities and Exchange Commission, said Rich Repetto, managing director and principal research analyst at Piper Sandler. It may even reduce the need to amend existing rules.
“Now that Gensler has presented the plan, there could be an innovation ahead of him that could get him where he wanted to be without any formal regulations,” Repetto told CNBC.
Repetto said that while it remains a pay-to-order variable, a market like the one that Apex is building could reduce profits for wholesale market makers.
According to Devin Ryan of JMP Securities, another alternative to Gensler’s proposals could be for the industry to return to “insourcing” or having brokers fill customer orders from the company’s inventory. This practice is only an option for large self-clearing brokerages with a large order flow. Fidelity does, for example. Charles Schwab and I* want to.
“This scenario may be more economical for the big players, but it will likely lead to more liquidity fragmentation and more questions about the quality of execution,” Ryan said.
Dan Gallagher, Robinhood’s chief legal officer, a former commissioner with the Securities and Exchange Commission, argued that given the current situation, retailers were no better off. Gallagher cited speed of execution, no commission, and no account minimum as reasons to maintain the status quo.
“It’s a very good retail climate. Going there and participating now is a bit worrisome,” Gallagher said at the same industry conference on Wednesday.
However, for traders, creating auctions with more competition may lead to progressively better prices. While this may seem “tiny,” around 1 cent for some trades, it does add, Kaposi said.
“If you do it over and over again, and give 10% better execution, it’s up to the retailer — that’s better execution on the buy-and-sell side, thus saving more money in their pockets,” Kaposi said. “It could have a significant impact and positively change the market structure.”
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