Robinhood, the GameStop rebellion brutally crushed by Wall Street
Market makers like to keep their trading practices secret for competition, reputation and security purposes, although they typically execute books of buy and sell orders on the same securities to make a profit on the difference between the bid price and the ask price.
Robinhood itself reveals that its payment for order flow is a fixed percentage of the spread made by the market maker.
As a theoretical example, a market maker could match 10 offers to sell 10 Robinhood shares for US$100 with corresponding orders to buy 10 Robinhood shares for US$99.95, the 5¢ spread US being his profit. About 2¢ of that goes to Robinhood as payment for order flow.
The higher the order flow volume of retail traders bidding against each other, the easier it is to create a profitable market, suggesting retail has never beaten The Street.
One outstanding regulatory issue is the fiduciary duty of best execution where an agent (i.e. Robinhood, the broker) must seek to obtain the best price on behalf of its client, the retail trader.
Market making improves liquidity by matching more buyers and sellers, but whether brokers and market makers sufficiently monitor best execution on behalf of regulators remains an open question.
The Securities and Exchange Commission is still undecided on the issue. It has a pending 2021 agenda item to modernize equity market structure rules, “relating to order routing, conflicts of interest, best execution, market concentration and publication of best execution statistics”.
If it prohibited order flow payment, Robinhood’s business model could be sunk. The stock is already down 74% from its July 2021 IPO price and 86% from highs above $70 last August.
It is more likely that the SEC will require US brokers and market makers to improve monitoring of best execution compliance to demonstrate its achievement.
Citadel boss Ken Griffin (worth an estimated $30 billion) has already said publicly that an order flow payment ban wouldn’t hurt his business, as it would just mean he pays less commissions to Robinhood, while receiving a similar order. volumes.
The best execution has already proven to be more damaging to Robinhood. In 2020, the SEC fined it $65 million for operational failures that deprived its retail traders of $34.1 million via lower transaction price execution, even after accounting for cost savings. through free brokerage.
In Europe, asset managers, retail brokers and the commercial arms of investment banks have long complained about regulatory overkill related to exchange oversight following the European Union’s decision. Markets in Financial Instruments Directive (MiFID) I and II legislative reforms.
An institutional money manager, for example, has a fiduciary duty to execute trades on behalf of its investors with the broker offering the best price available. Not with the broker who takes the fund manager to the longest lunches or the best sports matches.
In Australia and the United States, rules around exchange oversight are less prescriptive, but capital markets groups have performed better.
A Dealogic report showed that no European investment bank entered the global top 10 by equity capital markets transaction volume during the first quarter of 2022.
Former European powerhouses such as UBS, Credit Suisse, Deutsche Bank and Barclays have all lost in the past 10 years to American and Asian rivals due to regulatory pressure and self-inflicted problems.
The challenge for regulators is to strike the right balance between investor protection and free markets. Now, as Robinhood and other budget brokers push into the crypto pumping space to drive growth in user volume and fees, the challenge becomes ever more pressing.