Regulatory body Bafin plans to keep high-pressure on neobroker platforms.

European and US Regulators Scrutinize Neobroker Business Models

In a move to ensure fairness and transparency in the financial markets, European and American regulators are examining the business models of neobroker companies.

The Federal Financial Supervisory Authority (BaFin) in Germany and the European Securities and Markets Authority (ESMA) have expressed concerns about the Payment for Order Flow (PFOF) practice used by neobrokers such as Trade Republic and others. This business model, which involves receiving rebates from market makers in exchange for routing orders, has raised questions about potential conflicts of interest and inducements.

BaFin is particularly interested in scrutinizing the advertising of neobrokers to ensure that the PFOF practice does not run counter to the interests of customers. The regulator is also concerned about the transparency of costs in the neobroker business model and wants to ensure that customers are fully informed.

ESMA has asked national supervisory authorities to put this issue on the agenda in 2021 or early 2022. In a statement in mid-July, ESMA expressed concerns about the business model of rebates for neobrokers through trading partners.

Across the Atlantic, the US financial market supervisor, the Securities and Exchange Commission (SEC), has the neobroker business model on its agenda. SEC Chairman, Gary Gensler, is considering a possible ban on PFOF, citing concerns that the practice may not be in the best interest of the customer.

The discussion about a potential ban on PFOF is gaining interest in Europe as well. The EU Commission is considering exchanging ideas on the topic with the SEC. If multiple execution venues are offered to the customer, the customer should not be induced to give instructions that could prevent the securities services company from achieving the best possible result for the customer, regarding total fee.

Both BaFin and ESMA have emphasised that securities services companies can accept inducements only in exceptional cases, provided they meet the relevant disclosure, service quality improvement, and conflict-of-interest avoidance requirements of the WpHG or MiFID II.

As regulatory changes are set in motion on both sides of the Atlantic, the neobrokers may need to shift towards traditional fee-based models in the near future. This rule applies to the PFOF practice as well. BaFin reiterates that neobrokers may prioritise their own financial gain over the best execution for their customers due to the PFOF business model.

In conclusion, the regulatory scrutiny of neobroker business models is a significant development that aims to protect the interests of customers and ensure fairness in the financial markets. The discussions about a potential ban on PFOF and the emphasis on transparency and conflict-of-interest avoidance are key aspects of this regulatory push.