FCA to scrutinise interdealer broker activity for PFOF breaches

The Financial Conduct Authority (FCA) is stepping up surveillance of its tough rules on payment for order flow, with a keen eye on interdealer broker business.

In a Market Watch report published on Monday, the UK’s financial regulator said nearly all of the brokers it has visited since the beginning of the year have now stopped charging payment for order flow (PFOF) when acting in an ‘agency-like’ capacity.

Most brokers however still charge PFOF for what they consider to be interdealer broking business.

PFOF is the process in which banks and brokers receive payment from market makers in return for orders – effectively charging both sides of the transaction and thus creating a conflict of interest according to the FCA.

The FCA does not class commission payments in the interdealer broker market as PFOF because neither party relies on the broker or assumes the broker will be acting on their behalf.

However, the regulator said it will dig deeper into what firms are classifying as interdealer broking activities to ensure they are “applying consistent judgements across the market that align with the rules on managing conflicts of interest”.

The FCA also acknowledged that some brokers are booking transactions to overseas offices “so they could argue that they were allowed to charge PFOF”.

Similarly, it will continue to examine this type of activity looking for evidence of breaches. For example, when orders are handled by a UK broker but subject to two-sided charges.

The FCA also recognises that as of yet there is no evidence that brokers have implemented schemes or designed structures to circumvent the rules.

In an earlier statement to FOW the FCA said: “We do not currently have any enforcement investigations that have been initiated against firms for potential breaches of the payment for order flow rules.”

“However, this is an area of heightened supervisory focus and we have a number of initiatives to evaluate whether previous interventions and the tightening of rules under Mifid II have been effective and to identify whether there is misconduct in pockets of the market.”

This comes after a financial regulation expert told FOW in May that third country firms can get around the PFOF ban under Mifid II if they can show the contact was exclusively initiated from the client. However this is “incredibly hard for regulators to prove”, he said.

The FCA launched a probe into a group of London-based brokers over possible abuses of the rules back in 2015, but has yet to take any formal enforcement action.