Published: 19th October 2011

The FSA has issued consultative guidance on the practice of ‘payment for order flow’ (PFOF). PFOF is an arrangement whereby a broker receives payment, either in cash or other form, from a third party for directing order flow to the latter. However such arrangements could fall foul of the FSA’s rules on inducements, best execution and conflicts of interest.

In an ideal world the best execution obligation would mean that there should be no disadvantage to the broker’s client in using a market maker that had a PFOF arrangement with said broker. The FSA is concerned that this could attract orders that would not otherwise be obtained e.g. not offering the best price. Such an arrangement poses a potential conflict of interest between the broker and the broker’s client and should be identified as so by such brokers in keeping with SYSC 10.1.3. Firms are warned that disclosure of such a conflict (SYSC 10.1.8) is not a legitimate way of addressing such a conflict.

The paper effectively demolishes the practice by referring to the Inducements rules and in particular questioning how it can be argued that it will “.. enhance the quality of the service to the client” (COBS 2.3.1(2)(c)).

Comments, including responses to nine specific questions, are invited from market makers, brokers and other interested parties by November 9. The FSA expect to issue finalised guidance in Q1 2012.

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