The Upcoming Ban on PFOF in Europe - A Level Playing Field?

Everyone that has been following the discussion around Payment for Order Flow (PFOF) knows the BUX stance on this. We’ve been very vocal about this. But this article is not about the stance of BUX. It’s about the bigger picture of creating a level playing field. To make this a reality, EU policy makers are now working towards a full ban on PFOF. Or are they?

We all know that the Capital Markets Union (CMU) is high on the agenda for every Member State in Europe. The European Commission even made this a key project to build a single market for capital. I agree and fully support the believe that a CMU is crucial for the development of a strong and competitive financial industry in Europe.

On 28 April 2023 the major EU Policy makers released a statement regarding their discussion of EU capital markets in addressing strategic challenges for the EU. They also pledged to finalise work on the legislative proposals in this area before the European Parliament elections in 2024, allowing for decisive and concrete progress on a fully-fledged CMU. In this statement they even made the clear comment that there should be a targeted ban on inducements for execution-only transactions. Which is interesting as PFOF can be considered as a kind of inducement.

There is clearly a large push to come to a European wide agreement on how to deal with PFOF. However, the reality is that there are still Member States pushing their own agendas and trying to find ways to opt-out of the ban. The Council Working Group on MiFID is for example trying to push towards a compromise on PFOF by allowing for Member State discretion.

Let’s paint the picture here…

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What is PFOF again?

PFOF is a practice where brokers (typically retail brokers) receive payments from third-party firms for providing them with access to their trades. Essentially, trades are directed to market makers or hedge funds who then execute the trades on behalf of clients. In return, brokers receive payments from these third-party firms, either as a percentage of the spread or as a fixed amount per trade.

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Why a ban?

There are many opinions on PFOF, but to paint the contrast, there are two sides to this story:

1)?????One side believes PFOF is a conflict of interest and can therefore be detrimental to the retail client.

2)?????The other side believes PFOF is a necessity to help improve retail participation in the investment space.

For both sides, there are arguments in favour, and arguments against. In this article I don’t want to bring any subjective opinion forward on the role of PFOF itself, but rather focus on the future role of PFOF in the European landscape and the necessity for a level playing field.

In December 2022, EU Member States agreed on a general approach on the MiFIR/D Review CWG proposed regulation that left the discretion to individual Member States to allow PFOF only in their jurisdiction. However, in March 2023 the European Parliament voted to ban PFOF among brokers. When I first heard of the vote in favour of a ban, I was therefore surprised. We know how much resistance there is from certain Member States in Europe for a ban on PFOF. Many of the investment firms that are regulated in a country where PFOF is allowed rely heavily on PFOF to keep investing affordable for their retail clients. Due to this practice, they are often able to provide retail access for an attractive price, due to the additional revenue stream that PFOF generates.

At the same time, it gives them an advantage over other investment firms regulated in countries where PFOF is not allowed. Through European passporting it’s now very easy to market and offer services in all countries within the European Union (EU) while being regulated by only one of the Member States. Even in countries where PFOF is not allowed.

So that’s strange right? Let me give you an example: PFOF is fully banned in the Netherlands but is allowed in Germany. This means that a investment firm regulated in Germany can offer its services to Netherlands based customers and receive PFOF from their order flow. While any firm that is regulated in the Netherlands cannot receive any PFOF from their order flow, even if they offer their services in Germany…

This is especially interesting because regulators and law makers have been working towards a centralised capital market for years already in Europe through the CMU plan. Therefore, I would assume that the most important reason for the ban is to create a level playing field.

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Level the playing field

Even though a full ban on PFOF takes immediate care of the most important thing all European parties would like to accomplish: a level playing field, it seems like the interests are pushing policy makers to a compromise as well: the potential choice for local Members States to opt-out of this ban.

Wow. Doesn’t that go against everything we would like to accomplish? It significantly complicates the approach, it goes against the principles of the CMU, it goes against a level playing field, and it opens the door for all Member States to implement their own rules again.

The complications for implementing this approach internationally are not to be underestimated. Every investment firm would need to build and use a different integration per country to separate the order flow. If an investment firm is offering its services in a country where PFOF is allowed, the firm can receive PFOF from the residents in this country, however if this same firm offers its services in a country where PFOF is banned, this firm would not be able to receive any PFOF. Splitting this per country, considering all the local requirements, goes fully against the ambition of the CMU. In the worst-case scenario, it can even lead to 27 different practices across Europe, which is the exact opposite of what we’re trying to accomplish.

Luckily, leading lawmaker of the European Parliament Danuta Hübner understands the issue that comes with this quite well, stressing already in her draft report from March 2022 that the problems related to PFOF practices are symptomatic of a broader issue related to the best-execution regime and subsequent divergent supervisory interpretations.

And I fully agree here! I’m not rooting for a ban on PFOF here, but I AM rooting for a level playing field. If we would like to create a single capital market in Europe and we want to avoid regulatory arbitrage, then the only way to accomplish this is to have a single approach across all the Members States in the EU.

That would indeed mean that some lawmakers or governments might be disappointed. However, sometimes it’s necessary to take one step back in order to take two steps forward. So, let’s please look at the bigger picture here and make Europe a stronger, more resilient, and competitive market. There’s still so much more to gain by working together and create unity than by going backwards and have a fragmented market. Europe has too much to lose.