In 2020 and 2021 Citadel Securities ranks highest on how much was spent on payment for order flow (PFOF). Citadel paid a whopping $2.6 billion according to public documents and reports from the U.S Securities and Exchange commission (SEC). The company was the leader in the amount spent as a market maker, as Citadel Securities accounts for about one third of total market spend on PFOF. Following behind was Susquehanna, who spent $1.5 billion and Virtu who spent $654 million.
WHAT IS PAYMENT FOR ORDER FLOW (PFOF)?
Simply put, the process of payment for order flow means that a market maker pays brokers for the right to process the broker’s trades. For example in this case, market maker Citadel pays Robinhood (the broker) for the right to process their trades, and in doing so, the market maker then will earn a portion of the spread on each trade. While this is a well known process, some believe it could be one with conflict of interest.
While the process of PFOF creates the ability for brokers to offer free trades to its users, market makers like Citadel and associated brokers have ultimately been fined for not providing the best prices to customers.
IS PFOF ILLEGAL?
The practice of payment for order flow accounted for 81% of Robinhood’s revenue in the first quarter of 2021. Since this practice is such a large portion of brokers revenue, it draws a lot of attention to the practice and its authenticity. We’ve seen brokers and market makers questioned more than ever in the last year by the DOJ — especially with the absurd amount of trading halts and glitches. So it’s only natural for investors to continue to question trading practices.
Robinhood essentially profits off of sending as many of their orders to market makers, and the market makers skim the profit off the top from processing those trades. Investors question whether Robinhood is purposefully not providing retail investors with the best prices, because it would ultimately benefit the market maker in providing less than ideal pricing.
The questioning of the practice took place in UK and Canadian Governments in 2016 and the process of PFOF was then banned. A study of the United Kingdom’s decision to pan PFOF, ultimately found that the ban allowed retail investors to have better trading prices and related a better competitive market.