Finance Monthly - November 2021 Edition

20 Finance Monthly. F i nanc i a l Innov a t i on & F i nTech order-flow (PFOF). Like Facebook, Robinhood has a built-in conflict of interest with its users when it comes to its business model. We’ve all gotten a look behind the curtainat Facebook recently thanks to whistleblower Frances Haugen. We know that Facebook prioritises “engagement” and “stickiness” even at the expense of mental health. Facebook is rewarded when its advertisers make more money selling stuff to Facebook’s users. Facebook does not make more money for improving the mental health of teenage girls. We’ve seen what happens when push comes to shove, and we’ve seen that Facebook knows what is happening and has been unwilling to make needed changes that would impair Facebook’s present and future profits. Robinhood makes money when its users buy and sell more frequently because it gets paid PFOF by wholesale market makers when its users make a trade. No trades, no pay. Robinhood won’t disclose exactly the terms of how it is paid by wholesale market makers, but they do acknowledge that they earn a “percentage of the bid-ask spread.” So, what exactly does this tell us? It tells us two things: 1. Robinhood makes more money when buying and selling happens more frequently; and 2. It makes more money when the bid-ask spread is bigger, which means that they make more money when the trading happens in illiquid securities. These are the indisputable financial incentives of Robinhood as a business. These are its profit motives. These are the incentives that drove massive revenues for Robinhood during, for example, the GameStop (1Q21) and Dogecoin (2Q21) trading frenzies. Mr Tenev has attempted to portray Robinhood as a victim in the GameStop frenzy (as he has again done in his WSJ OpEd) but no single event in 2021 did more for Robinhood’s market value than the GameStop trade. Mr Tenev regularly argues that “brokerage firms have used this practice for decades” and that this is nothing new. That is true as far as it goes, but no brokerage firm has ever used it at the scale and efficiency of Robinhood. Moreover, what Robinhood has not told us is what percentage of the bid-ask spread Robinhood takes. The data strongly suggests that Robinhood is getting paid more per trade than any other broker. Here is how Piper-Sandler Managing Director Richard Repetto, CFA put it in a recent industry note on 2Q 2021 retail PFOF. “HOOD earned the highest average rate among the large eBrokers on both equities and options in 2Q21. Innovation in charging for PFOF enabled HOOD to earn the highest average rate per share on both equities ($0.0023) and options ($0.0060) in 2Q21. We suspect that the elevated average rate earned is driven by (1) more profitable order flow, (2) execution quality and (3) payment methodology (charging a fixed rate per spread on equities rather than fixed rate per share). HOOD is the only eBroker to charge a fixed rate per spread on equities.”