On 9 February 2022, the Dutch Authority for the Financial Markets (Autoriteit Financiële Markten, the AFM) published the results of a study into the quality of order execution on payment for order flow (PFOF) trading venues. The report containing the AFM’s findings is titled ‘Assessing the quality of executions on trading venues: The “Comparative Pricing Model”’(the Report).

In the introduction of the Report, the AFM notes that this study follows the emerging worldwide public debate on the risks and presumed benefits of the practice of PFOF and the call from the European Securities Markets Authority (ESMA) on national regulatory authorities to further investigate the risks arising from PFOF. According to ESMA and the AFM, PFOF causes a conflict of interest between the firm and its clients, because it provides the firm with an incentive to choose the third party offering the highest payment, rather than the best possible outcome for its clients when executing or routing their orders for execution.

For this study, the AFM has assessed the execution quality of two PFOF trading venues and one non-PFOF trading venue, all three used by pan-European operating low-cost neo-brokers, as well as one low-cost investment firm. According to the AFM this selection was made on the basis of criteria such as data availability and a substantial presence of activities in multiple European countries. The AFM notes that the initial results of its analysis show that the PFOF trading venues structurally offered worse execution prices when comparing with real transactions with multiple other trading venues.

In order to assess execution quality, the AFM developed an assessment methodology which should provide a robust indicator of a trading venue’s execution quality based on post-trade data: the Comparative Pricing Model. According to the AFM, this methodology is easy to replicate by other national regulatory authorities using their own available data sets. The AFM applied the Comparative Pricing Model to review how execution prices of shares on one trading venue compare to prices of execution on multiple other trading venues. The AFM believes that this use of multiple trading venues establishes an appropriate benchmark.

As part of its analysis, the AFM considers the price of a transaction to be:

• better in case a client is settling at a higher price (or buying at a lower price) than the price of any transaction on any reference trading venue (in the same instrument in the same second);
• worse in case a client is settling a lower price (or buying at a higher price than the price of any transaction on any reference trading venue (in the same instrument in the same second); or
• of similar quality if neither of the above applies.

The AFM notes that the results show that for the two PFOF trading venues, most retail client transactions were executed at a worse price in comparison to the most liquid reference markets. For most of the transactions (68 to 72% for PFOF trading venue X and 81 to 83% for PFOF trading venue Y) the execution price was worse. On PFOF trading venue X the average price deterioration for a transaction of € 3,000 is € 1.44, on PFOF trading venue Y this was € 3.46. For the third trading venue (Z), a non-PFOF trading venue, most of the retail client transactions were executed at a similar price (74 to 77%) compared to the reference markets, with the average price deterioration for a trade of € 3,000 being € 0.24. For the investment firm that was examined, the percentages of worse, better or similar execution prices are almost evenly divided, with the average price deterioration for a transaction of € 3,000 being € 0.42.

The Report contains a description of the methodology used by the AFM (section 2), the outcome of its analyses (section 3), specification of the Comparative Pricing Model (Annex I) and a set of Q&A (Annex II).

The AFM has been making it clear that it believes that PFOF is an undesirable model and prohibited in the Netherlands. The AFM wants to see an EU-wide ban to prevent lack of cost transparency towards investors, but also to ensure a level playing field.