Regulatory body, Bafin, intends to keep neobroker companies under scrutiny.
In a move to protect the interests of customers, Germany's Federal Financial Supervisory Authority (BaFin) has announced it will closely examine the advertising of neobrokers to ensure that Payment for Order Flow (PFOF) practices do not contravene customer interests. This decision follows concerns raised by the European Securities and Markets Authority (ESMA) about potential conflicts of interest in the neobroker business model.
Neobrokers, which offer securities trading virtually for free, have gained popularity due to their seemingly advantageous fees. However, the business model behind these services is under scrutiny. The model involves exclusive collaborations with a few market makers, who provide rebates in return for securities orders. This arrangement has sparked worry that neobrokers may not always choose the most favorable execution partner for the customer, but rather the one that offers the highest rebate.
ESMA has warned about these risks and has expressed concerns about the rebates for neobrokers through trading partners. The European regulatory body has asked national supervisory authorities, including BaFin, to address the issue of potential conflicts of interest in the neobroker business model in their agendas for 2021 or early 2022.
BaFin shares ESMA's concerns about neobrokers potentially violating the European financial market directive MiFID II. In 2021 and spring 2022, both BaFin and ESMA have meticulously monitored companies potentially violating the MiFID II directive by applying the PFOF business model. Firms frequently and systematically trading stocks and similar financial instruments for their own account outside regulated markets or multilateral systems, who execute client orders outside such systems without operating a multilateral trading facility, have been subject to enhanced supervisory focus.
German financial supervisors will now scrutinize neobrokers more closely. BaFin reminds securities services companies that they may only accept inducements in exceptional cases, and PFOF practice is included in this. If a customer is induced to give an instruction that prevents the securities services company from achieving the best possible result for the customer, it may be a violation.
The issue of PFOF is not limited to Europe. SEC Chair Gary Gensler is considering a possible ban on this practice, and this approach is gaining interest in the US. Gensler was invited to exchange thoughts on the topic with the Economic and Monetary Affairs Committee of the European Commission this week.
While the future of neobrokers remains uncertain, it is not entirely unlikely that these online brokers will have to switch from free orders to charging customers in the classic way. As the regulatory bodies continue to monitor the industry, customers are encouraged to stay informed about the practices of their securities services providers.
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