Why understanding Payment for Order Flow (PFOF) is important if you trade and invest Why understanding Payment for Order Flow (PFOF) is important if you trade and invest Why understanding Payment for Order Flow (PFOF) is important if you trade and invest

Why understanding Payment for Order Flow (PFOF) is important if you trade and invest

Thought Leadership 3 minutes to read
Adam Reynolds
Adam Reynolds

APAC CEO of Saxo

Summary:  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.


Since 2020, we have seen an acceleration of a global trend expedited by the pandemic, of more people taking greater control over their savings and investments. This greater participation and empowerment of retail investors will remain a dominant market force for the foreseeable future. 

As more people now access the capital markets, it’s more important than ever that investors are given better access to company and trading data, to improve their access to funding and broaden their investment opportunities.

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 will level the playing field for investors and bring more transparency, so that clients know they are not selling their flow to market makers. 

But what is Payment For Order Flow, and why is it important for retail investors to be sure their brokers are not practising it?

What is Payment For Order Flow (PFOF)?
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.

Payment For Order Flow is a method of transferring some of the profit from market making to the brokers that route customer orders to the market maker. In this manner, the broker generates an additional source of income, while the market maker ensures retail volume is being routed their way, which in return simplifies their practice of market making (matching buy and sell orders) and ultimately leads to higher profits for the market maker as well.

Why should retail investors care?
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. 

Moreover, as this process has become so widespread that it is reducing liquidity and likely influencing prices at exchanges – with orders executed elsewhere - it has proved controversial, and is receiving attention from regulators around the world.

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.

Further, many of the market makers to whom order flow is sold are hedge funds. As such, they are in a position to use the information in the flow to inform their own algorithmic trading decisions, and to trade with very high frequency in the market, much more so than any retail investor ever could. Investors are often unaware that their orders are sold to hedge funds, and of the impact this can have. 

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.

Technology as a way to level the playing field
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 your orders to the venue offering best execution independent of Payment For Order Flow.

In short, we source the best price available for the client, and we aren’t distracted by which hedge fund we can sell our clients’ orders to. 

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. 

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • 350x200 peter

    Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • 350x200 althea

    Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • 350x200 peter

    Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • 350x200 charu (1)

    FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • 350x200 ole

    Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.