Market makers association warns against loopholes in European ban on payment for order flow

The association said the European Commission’s definition of PFOF in its MiFID II amendments is vague and leaves potential loopholes for those trying to skirt the new rules.

The Futures Industry Association European Principal Traders Association (FIA EPTA) has welcomed the European Commission’s move to ban payment for order flow (PFOF) under MiFID II but warned against potential loopholes in the changes.

Brussels moved to prohibit PFOF for “high-frequency traders organised as SIs [systematic internalisers]” on 25 November as part of its Capital Markets Union (CMU) action plan. Under the changes, venues will instead have to earn retail order flow by publishing competitive pre-trade quotes.

In a follow-up statement to the changes, FIA EPTA said the Commission’s definition o left large gaps around what is considered PFOF, how its practiced and who can practice it.  and subsequently left loopholes that would allow these practices to continue in the EU.

The association said it is “critical” these loopholes are closed and suggested the Commission advocate a ban on PFOF that encompasses all direct and indirect monetary and non-monetary inducements, including all possible execution and routing scenarios between all types of participants.

“In FIA EPTA’s view these practices, which are observed in some member states, constitute an inappropriate conflict of interest, which undermines fair competition between market participants as well as best execution for end clients,” said Piebe Teeboom, secretary general of FIA EPTA.

“These practices [PFOF] undercut EU investor protection standards and ultimately risk to disadvantage and, in due course drive away, the very retail investors whose participation in European capital markets will be critical to their success.”

Elsewhere the FIA has voiced conditional support for the Commission’s plans to implement a consolidated tape in Europe.

The European Commission set out plans last week to introduce a real-time post-trade single consolidated tape provider for each asset class. However, FIA EPTA said that the scope of the derivatives tape was unduly narrow and suggested an equally comprehensive tape to the ones proposed for equities and bonds be implemented.

It also added that the Commission’s changes to bond market transparency – which includes harmonising the deferral regime and shortening post-trade publication delays – need to include a blanket 15-minute deferral as currently the changes are ambiguous and risk creating an overly complex regime with referrals ranging from 15 minutes to two weeks.

“This will also be the case for large-size transactions when jointly implemented with an effective volume masking regime, ensuring that liquidity providers are not exposed to undue risk and are still able to effectively hedge even after the deferral window has expired since the market does not know the full-size of the large trade,” added Teeboom.

The Commission’s consolidated tape proposals have attracted mixed reviews from various associations. Overall, the industry welcomes its introduction, but many have suggested improvements to the system proposed by the Commission.

 The Association for Financial Markets in Europe (AFME) has requested the consolidated tape for equities include pre-trade data, as well as the post-trade data the Commission has suggested to include and recommended that Brussels ensure the development of a bond consolidated tape before actioning any changes to the post-trade transparency regime. 

“This will avoid exposing committed liquidity providers to potential undue risks, especially when trading in illiquid instruments or transactions above a certain size, because if not properly considered, it may lead to diminishing liquidity available to corporates and investors,” said Adam Farkas, AFME chief executive.