Hey ya’ll. John Collins here, again. I took a week off to concentrate on the NBA Finals so it’s been a month since we last saw each other. I missed you too!
In the meantime, there’s been a lot going on. It feels like more than usual? And it’s the summer? It was hard to try and figure out what to write about but Julie told me to write about Payment for Order Flow (PFOF) and I do what the boss says.
Gary Gensler, the new head of the SEC, has been busy testifying before Congress two weeks ago and then doing a flurry of media this week. Julie included his interview with CNBC in Tuesday’s newsletter but if you haven’t seen it yet - do.
The interview was focused on some of the newsier items of a speech he delivered yesterday at the Global Exchange and Fintech Conference. As we’ve talked about here in the past, he’s a market infrastructure guy. He always has been. Our expectation that this would be his focus (kind of an obvious one, tbh) as SEC Chair has proven correct, much like my opinion that Mare of Easttown is actually bad and the ending is dumb. (Editor’s note: Julie thinks John is very wrong on Mare of Easttown).
The tl;dr on where Gensler is: Gensler seems to be wanting to “balance” innovation and regulation, but he’s gunning for Payment for Order Flow and gamification.
The Big Picture
His macro view is that technology has dramatically changed the way market makers, trading platforms, and retail investors operate and interact. The rules put into place 16 years ago need to be modernized, or, as he put it, “freshened.”
As it relates to Payment for Order Flow, he is concerned about two things:
- Segmentation - Where are these trades happening?
- Concentration - Who is executing those trades?
He notes in his speech that 53% of trading volume is happening in “lit markets,” like NYSE, Nasdaq, etc.
The remaining 47% are happening in “unlit” markets - 9% in “dark pools” and the remaining 38% being executed by off-exchange wholesalers.
Where concentration comes in, as he says in his speech, is that only seven wholesalers make up a majority of the trades within this segment. He believes this concentration limits “healthy competition and limit[s] innovation,” in addition to presenting greater potential for market failures and increased opportunities for investors to be hurt.
Gamification and Data Concentration
The brokerages make more money from PFOF the more their customers trade. In turn, a small number of wholesalers/market makers are receiving more and more data on those trades. Gensler is concerned about the concentration of that data and its ability to be used against the average person trading on any number of the free, online brokerages. He posits that, if the customer is getting a worse price/worse execution, it’s not really free. In fact, he pretty much said on CNBC that it’s not free at all, and, in his speech, that it may be more expensive to the investor than just paying a flat fee for a trade like we did in the olden days.
Of course, gamification plays a role here because if you’re incentivizing people to trade more with user prompts, emails, confetti, etc., etc., then the exchanges get more sweet, sweet PFOF and the cycle above continues.
If his testimonies before Congress, his speeches, and media interviews are any indication, the days of “free” trading and gamification could very well be coming to an end. All of this of course at a time when one of the major players, Robinhood, is about to go public, which is, uhm, not ideal for them.
New Rules and Enforcement Actions?
One more thing I will note, because I found it curious. When asked on CNBC whether or not the solution here might just be better education for investors, Gensler sort of sidestepped the suggestion. Instead he mentioned, several times, that they (the SEC) also has enforcement authority. Does that mean we’re not just going to see “freshened” rules but more enforcement actions as we saw with Robinhood?
He’s asked his staff to help with recommendations on Regulation NMS, payment for order flow (both on-exchange and off-exchange), minimum pricing increments, and the NBBO [national best bid and offer], with the aim of continuing to make our markets as efficient as possible.
The SEC is charged with ensuring fair, orderly, and efficient markets. The acronym there is FOE. There’s something clever there but probably too cutesy for me to offer with any real sincerity. That said, here were my candidates:
- “And it appears Gensler’s FOE might just be Payment for Order Flow.”
- “Fee fi FOE fum… is Payment for Order Flow going to soon be done?”
- “Only time will tell if Gensler is friend or FOE of Payment for Order Flow.”
That’s it. Thanks for playing. And wish me luck on Friday as I take on the Sixers.