The Financial Conduct Authority (FCA) has today published its thematic review on payment for order flow (PFOF) (TR14/13). PFOF is the practice of an investment firm which executes client orders, receiving commission both from clients and from the market maker counterparty.

For the purposes of this thematic review, the FCA sampled 36 firms. To reflect a broad spectrum of the industry, the FCA chose to investigate investment banks, contract for difference providers, wealth managers, brokers/interdealer brokers and retail banks. The FCA sent information requests, conducted desk based reviews and carried out a number of onsite visits in order to reach its conclusions. The guidance it has published today will be of interest to all firms that execute, receive and transmit or place orders for execution, including investment managers.

The FCA has concluded that the risks of PFOF are that transparency and efficiency of the price formation process can be undermined if such practices continue to exist. This in turn damages market integrity, inhibits competition and causes detriment to consumers. The FCA has therefore endeavoured to provide guidance to industry participants by highlighting poor practices and what needs to be done next.

The FCA’s key findings in relation to PFOF were:

  • PFOF arrangements create a clear conflict of interest between the firm and its clients, are unlikely to be compatible with the FCA’s inducements rules and risk compromising compliance with best execution rules; and
  • the FCA found during the course of its thematic review that a small number of market participants still continued to receive PFOF by changing the description of the service they provided to clients. Even with this amendment (known as a recast PFOF), this remains inconsistent with the economic realities of the firm’s activities nor is it compatible with FCA rules. As a result of the FCA’s clarification on this, those firms concerned have all ceased receiving PFOF.

The FCA is keeping this area under active review and has stated its intention to take action against firms which evade the FCA’s requirements on PFOF.

What firms should do next?
The FCA anticipates that firms need to review their practices to ensure they are not receiving PFOF, that their business practices are fit for purpose and that these are supported by appropriate second line of defence controls. Current systems and controls should be improved and firms should be ready for the implementation of future policy changes, bearing in mind the new upcoming MiFID II requirements.

View TR14/13: Best execution and payment for order flow, 31 July 2014