The European Securities and Markets Authority (ESMA) issued a public statement to remind firms that the receipt of payment for order flow (PFOF) raises significant investor protection concerns. It also highlights key MiFID II obligations aimed at ensuring firms act in their clients’ best interest when executing their orders.
ESMA is of the view that, in most cases, it is unlikely that the receipt of PFOF by firms from third parties would be compatible with MiFID II. In addition, ESMA also addresses specific concerns regarding certain practices by zero-commission brokers.
In the public statement, the European regulator reminded zero-commission brokers “of the MiFID II requirement to provide fair, clear and not misleading information to their clients and to provide information on all costs and charges to the client relating to the service and the financial instrument(s).”
“As clients of “zerocommission brokers” will always incur costs (e.g. implicit costs and third party payments received by the firm), ESMA emphasises that the marketing of the service as ‘cost-free’ in the circumstances described above, will infringe the firm’s compliance with these requirements and it could incentivise retail investors’ gaming or speculative behaviour due to the incorrect perception that trading is free.”
PFOF is the practice of brokers receiving payments from third parties for directing client order flow to them as execution venues. PFOF causes a clear conflict of interest between the firm and its clients, because it incentivises the firm to choose the third party offering the highest payment, rather than the best possible outcome for its clients when executing their orders.
ESMA is telling firms that they must thoroughly assess whether, by receiving PFOF, they are able to comply with relevant MiFID II requirements, most notably those on best execution, conflicts of interest, inducements and cost transparency.
ESMA also requests National Competent Authorities, especially in those Member States in which PFOF has been observed, to prioritise this topic in their supervisory activities for 2021 or early 2022. These activities should aim at assessing the actual impact of PFOF on firms’ compliance with relevant MiFID II requirements.
Firms receiving PFOF from third parties shall comply with the MiFID II inducements requirements, inter alia requiring PFOF to be designed to enhance the quality of the investment service to the client. On this aspect, ESMA issued a Q&A clarifying some basic principles, such as the need that the quality enhancement provided should go beyond aspects of the firm’s organisation or services that are legally required or that can be considered as essential for its functioning.