TradeTech: Could European regulators be set to ease off on payment for order flow?

Speaking in a keynote regulatory panel, the European Commission’s Tilman Lueder said lessons had been learned since Europe proposed a ban on payment for order flow in November. 

European regulators could be on the brink of easing off of proposed restrictions around payment for order flow (PFOF), a regulatory keynote panel at TradeTech has revealed.

Speaking on the panel, head of the securities markets unit at the European Commission, Tilman Lueder, implied that regulators could be set to ease off of restrictions on PFOF.

The Commission proposed to prohibit payment for order flow for “high-frequency traders organised as SIs” as part of its Capital Markets Union update in November. Under the changes, venues will instead have to earn retail order flow by publishing competitive pre-trade quotes in yet another move to level the playing field between execution venues.

“Since we proposed this ban we’ve learned a lot. Whoever proposes any kind of legislative changes to PFOF will make themselves a hostage to fortune. You start with big ideas but you discover lots of detail on how it is used in different markets and I think it’s fair to say PFOF is used in a different manner in Europe as it is in the US,” Lueder told the crowd.

“Some member states see PFOF as positive because it allows smaller platforms to aggregate order flow and execute outside of the big exchanges and in terms of explicit costs that’s certainly cheaper and in terms of the implicit costs that’s open to debate. If firms want to prove that they are achieving best execution and have lower implicit costs then we need a voluntary quotation tape and a complete quotation tape.”

Payment for order flow is also a hot topic on the agendas of regulators in the US with potential limitations also due to be imposed by SEC Chair Gary Gensler. Also speaking on the keynote regulatory panel, former SEC Commissioner and executive director at Milken Institute Centre for Financial Markets, Michael S Piwowar, said an outright ban was not likely but new limitations were unavoidable.

“We had the trading frenzy around GameStop in January 2020 and then we had the congressional hearing and PFOF became a big issue. Doing nothing is not an option, he [Gensler] has to do something. An outright ban is not on the table. One of the unintended consequences of that is we’ll probably end up losing 0 commissions so people will end up paying more,” he said.

“There will probably be some kind of enhanced disclosure with the stats out there around 605 and 606. You can’t do it on broker by broker or stock by stock basis. That was very non-controversial. It’ll be disclosures plus something else to appease those who want a ban. That could be limitations on payment for order flow or limits to exchange’s access fees etc.”

Other limitations in the US potentially on the horizon could also include lowering tick sizes or increasing the threshold for exchanges to be able to qualify as a protected quote, moderator Ari Burstein, general counsel and chief policy officer at Imperative Execution and moderator of the panel, added.

Data is another key area up for regulatory debate on both sides of the pond. Regulators in Europe and the UK have moved to investigate rising market data costs and concerns around competition between market data providers.

In the US, the SEC implemented the data infrastructure rule in December 2020 including changes around odd lot transactions and depth of book data.

“Once you get beyond that in terms of market data revenues then you’re into big picture and it gets beyond data. Fights between before profit exchanges that are also self-regulatory organisations and then the broker dealers,” said Piwowar.

“When the governance around NMS plans and the national market system were put in place they did not factor in for profit exchanges there wasn’t the conflict of interest that there is now. These have to be dealt with as you get the natural evolution of governance in the market.”

For Tilman, changes to crypto regulation in Europe and developing market structure projects including a DLT pilot scheme could enhance trading data.

“It’s an aggregation of a very fragmented market. Crypto actually would serve as a market integration tool so we’re keen to have a couple of projects with a simplified legal framework,” he said.

“If new technology comes along that simplifies the data dissemination, the trading process, the clearing process, the settlement process, that’s a good thing. Crypto and DLT could actually also get us better access to trading data itself.”