Under current Canadian financial laws, payment for order flow is not allowed on Canadian listed securities, however Canadian brokerages may accept payment for order flow on non-Canadian listed securities such as US securities.
What is Payment for Order Flow?
Payment for order flow (PFOF) is a practice where a stockbroker receives compensation from a market maker or liquidity provider for directing its clients’ trade transactions to that market maker.
A market maker is a broker (could be an individual or a firm) that quotes both sell and buy positions for a tradable asset to turn a profit off the bid-ask spread.
By being able to act on both sides of a transaction as the buyer and the seller, market makers can make profits through narrow spreads.
In Canada, Wealthsimple recently announced that they now accept payment for order flow on US listed securities and options which has Canadians questioning what ‘PFOF not being allowed in Canada’ really means.
In simple and straight-forward terms:
Payment for order flow cannot be accepted by Canadian brokerages on Canadian listed securities and options.
However, for non-Canadian listed securities, Canadian brokerages adhere to the trading laws where execution occurs.
Meaning, Canadian brokers can actually accept PFOF, just not on Canadian securities.
How does Payment for Order Flow Work?
As the SEC defines it, payment for order flow is “a method of transferring some of the trading profits from the market makers to the brokers that route customer orders to specialists for execution.”
With better trading technology and the increasing accessibility to the stock market by retail investors, trading has become increasingly complex.
There are thousands of stocks spanning multiple exchanges, which adds to the difficulty of executing orders.
For this reason, the number of market makers has grown in the US.
Instead of being compensated directly from their clients, brokers mass sell shares to market makers for the execution of the order.
The brokers are compensated in exchange for the stock traffic directed to the market makers.
With PFOF offering a revenue stream to these brokerages, many can provide 0% trading fees for their clients.
The practice has been called into question since many customers are unaware that their brokerages were directing their orders towards specific market makers that may not be getting the best price at the time the transaction was placed.
Did You Know?
Payment for order flow was a large part of the GameStop saga. There were rumours at the time that Citadel Securities, which handled Robinhood’s PFOF orders and accounted for 40 percent of Robinhood’s revenues, played a part in the brokerage firm shutting down trading.
Brokers that Receive Payment for Order Flow in Canada
Various brokers in Canada accept payment for order flow on the trading on non-Canadian listed securities.
|RBC Direct Investing||Yes||Operation Agreement||RBC Direct Investing may receive payment in the form of cash, rebates and/ or credits against fees in return for routing client orders pursuant to these order routing arrangements|
|CIBC Investor’s Edge||Yes||Best Execution Disclosure and Capital Markets Disclosure||In some instances, CIBC Capital Markets may receive payment for order-flow|
|Scotia iTRADE||Yes||Disclosure Document||Depending on the market or marketplace to which your orders may be routed, we may receive remuneration for directing orders to a particular broker-dealer or market center for execution|
|BMO InvestorLine||Yes||Trade Execution Disclosure||In executing clients’ orders, BMO may incur certain costs, or receive rebates or other payments, depending on the marketplace or intermediary, including a foreign intermediary, where orders are routed.|
|TD Direct Investing||Yes||Best Execution and Fair Pricing Disclosure||TDWCI receives payment in the form of a rebate from TDSI and TDA in return for routing client orders in U.S. equities and options pursuant to the order routing arrangement. In accordance with the routing agreement, TDSI and TDA will allocate to TDWCI a portion of the payment for order flow revenue received.|
|National Bank Direct Brokerage||No||Annual Disclosure||NBCFI is currently not engaged in any Payment for Order Flow arrangements|
|Interactive Brokers||No for IBKR-Pro
(Only offering available in Canada)
|Disclosure||Outlines routing practices|
|Wealthsimple||Yes||Help Article||Wealthsimple may receive Payment for Order Flow (or PFOF) on US-listed securities and options|
|Questrade||Yes||Order Routing Disclaimer||Questrade may receive remuneration in the form of cash, rebates and/or credits against fees in return for routing client orders pursuant to these order routing arrangements.|
|Qtrade||Yes||Customer service email||Qtrade’s US orders are sent to the US and are executed on the market or exchange which has the best price for the client (Best Execution). Qtrade does receive payment for order flow.|
Brokers that Receive Payment for Order Flow in the US
Popular brokers that receive payment for order flow in the US include:
Benefits and Drawbacks
Zero Commission Trading
PFOF allows brokerage platforms to charge zero-commissions to their clients.
This is appealing and can convince more potential clients to sign up use the service since they can trade free of charge.
All Parties Win
Market makers claim they can outperform the national best bid and offer so everyone gets what they want and no one is taken advantage of.
No Regulation of the Profit Split
Market makers can decide how much profit they, the brokers, and the clients receive.
This can be skewed in favour of one more than the others without oversight.
Conflict of Interest
Payment for order flow conflicts with the brokers’ duty of completing the best execution in their clients’ interests.
The market makers can skim higher profits if the buy and sell spread are more significant, which leaves no incentive to follow best execution practices.
Which Countries Allow Payment for Order Flow?
United States of America
At the end of 2021, SEC Chair Gary Gensler put banning Payment for Order Flow on the table.
Despite this, no move has been made to ban the practice, and it continues to be legal in the US.
According to the current SEC regulations, brokers are required to disclose their policies with PFOF and publicize any business relations they have with market makers.
Brokers are also required to notify clients if they were compensated for directing their orders to market makers for execution.
European legislators have regulations to limit Payment for Order Flow, but this practice does exist in Europe.
Even though market makers are not allowed to directly compensate the brokers, workarounds within the laws still allow forms of compensation.
Brokers and market makers can execute the order together and have a more favourable outcome for the market maker.
In return, the broker gets compensated by the market maker, and the retail trading service can offer commission free trading to its clients.
Payment for Order Flow Policy Changes
In early 2020, Rule 606 was changed to require brokers to report all net payments received monthly from market makers for any trades made in S&P 500, option trades, and non-S&P 500 equity trades.
They are also required to disclose the Payment for Order Flow rate per 100 shares by order type.
Does Wealthsimple Accept Payment for Order Flow (PFOF)?
Yes, as of November 2022, Wealthsimple accepts payment for order flow on US listed securities and options.
Frequently Asked Questions
- Why would a company pay for order flow?
If a company has sufficient order flow coming through its systems to be executed, it can capitalize on the bid-ask spread. It can then execute the order at the largest gap in the spread and capitalize on the difference. It doesn’t seem like much with a few hundred orders, but with millions of orders coming in daily, it can quickly become a lucrative business.
- Is paying for order flow legal?
Depending on the country, a broker may or may not be allowed to use this practice. It is still accepted in the US and European Union but it is banned in Canada on Canadian listed securities, the United Kingdom, and Australia due to conflict of interest.