The U.S. Securities and Change and Fee (SEC) is contemplating a full ban on a controversial apply within the brokerage trade, often called fee for order movement (PFOF), in accordance with Chairman Gary Gensler, who was not too long ago interviewed by Barron’s.
On Aug. 30, the day Barron’s revealed the interview, Robinhood Markets (NASDAQ: HOOD) inventory plunged practically 7% to complete at $43.64.
The corporate made its Wall Avenue debut in late July and has risen nearly 25% because the IPO, in accordance with knowledge compiled by Refinitiv.
This put up will discuss you thru fee for order movement, how this apply works, Robinhood’s enterprise mannequin, and how a ban on PFOF might have an effect on the favored brokerage app.
So, with out additional ado, let’s soar proper in.
About Robinhood
Robinhood is a web-based brokerage agency that was co-founded in April 2013 by Vladimir Tenev and Baiju Bhatt.
It was the primary dealer to supply commission-free on-line buying and selling for U.S. shares and exchange-traded funds (ETFs), a transfer that noticed conventional brokerages Charles Schwab (NYSE: SCHW) and E*Commerce really feel the warmth and comply with swimsuit in 2019.
A part of Robinhood’s success has stemmed from efforts to make investing enjoyable (gamifying its app) to stimulate buying and selling and entice each millennials and Gen Z.
Robinhood additionally permits buyers to entry the retail market, together with preliminary public choices, and has enabled its customers to commerce in belongings like cryptocurrencies.
However critics and regulators argue that Robinhood and different brokers that gamify their buying and selling apps have turned the inventory market right into a sport, which newbie merchants are too desirous to play with out first understanding what’s at stake and understanding the principles.
All in all, Robinhood’s zero-commission mannequin and its user-friendly app, have made buying and selling a lot simpler and cheaper for unusual merchants, regardless of their expertise, attracting greater than 21 million month-to-month lively customers on the final rely.
What’s the which means of “fee for order movement”?
Cost for order movement, or PFOF, is a controversial and complex apply accomplished by brokerage corporations comparable to Robinhood and Charles Schwab, whereby they settle for cash (sometimes, fractions of cents) from “market makers” in change for routing shopper commerce orders.
The entire concept of commission-free trades is tied to fee for order movement. First, a dealer submits a promote or purchase order for inventory via Robinhood or one other on-line dealer.
The dealer then passes that order alongside to a third-party market maker. Market makers are sometimes giant banks or establishments that present liquidity to the market by providing to each purchase and promote securities in giant orders.
After receiving the receiving, the order, the market maker pays the dealer a small price.
As soon as the market maker executes the commerce, it buys the shares at a reduction to the worth at which it sells them, pocketing the distinction as revenue. That distinction is named the “bid-ask unfold.”
Robinhood and different buying and selling platforms have found out that they’ll make more cash promoting buyer orders within the present local weather than by charging small charges on to prospects for every commerce.
They argue that fee for order movement offers higher costs for merchants and has opened up new markets. Nonetheless, some regulators and shopper advocates criticize the apply, claiming that it presents an inherent battle of curiosity.
By the best way, do you know that fee for order movement was pioneered by the late Ponzi scheme king Bernie Madoff within the Nineteen Nineties?
How a ban on PFOF might have an effect on Robinhood
Since Robinhood doesn’t cost its customers commissions to commerce, it will get most of its income from fee for order movement.
In its second-quarter earnings report, the primary since going public, Robinhood revealed a lack of $502 million, in contrast with a revenue of $58 million from the year-ago quarter.
The dealer mentioned an enormous chunk of that loss was on account of warrants from an emergency funding spherical it raised this yr.
Nonetheless, it grew 131% to $565 million in the course of the second quarter from the $244 million it had throughout the identical interval final yr.
In line with the report, Robinhood derived round 80% of the income from PFOF, or funds it acquired for routing orders for shares, cryptocurrencies, and choices to market makers.
Based mostly on these monetary outcomes, it’s very straightforward to conclude {that a} ban on fee for order movement, might have a detrimental influence on Robinhood’s revenues.
Gensler advised Barron’s that PFOF has “an inherent battle of curiosity” and {that a} full ban of the mannequin “is on the desk.”
The SEC boss additionally added that on high of creating a small unfold on every commerce, market makers additionally obtain knowledge, the primary have a look at a commerce, and the power to match merchants from the order movement they get from brokerages.
Whereas Gensler didn’t state whether or not the SEC officers had discovered circumstances the place buyers had been harm by conflicts of curiosity, he warned that PFOF “is probably not essentially the most environment friendly for the 2020s.”
Backside Line
Robinhood has been one of many largest winners in the course of the Covid-19 pandemic, due to its easy and user-friendly buying and selling app that has made it straightforward to commerce shares, choices, and even cryptocurrencies.
Earlier this yr, the app drastically contributed to wild strikes in so-called meme shares comparable to GameStop (NYSE: GME), AMC Leisure (NYSE: AMC), and BlackBerry (NYSE: BB).
However Robinhood additionally confronted excessive criticism on the top of the meme-stock buying and selling frenzy because the dealer and a few of its rivals restricted buying and selling of sure shares due to elevated capital necessities from clearinghouses.
Throughout a February congressional listening to about Robinhood’s meme-stock buying and selling debacle, numerous lawmakers centered on PFOF, blaming it for the dealer’s choice to dam buying and selling of some shares.
Now, it stays to be seen what Robinhood will do as SEC seems into PFOF over issues the apply might incentivize brokerages to promote buyer orders to market makers that maximize their very own earnings as a substitute of creating it straightforward for its prospects to execute their trades.
One factor is definite, nevertheless: Robinhood and its friends must begin charging commissions to keep away from going if the SEC declares a full ban on PFOF.
In line with this Bloomberg article, the entire Robinhood period of excitable retail buying and selling, meme shares, and options-driven value strikes could be gone without end.
