Speaker 1: Hello, and welcome to another episode of the Odd Lots podcast.
Speaker 1: I'm Joe Wisn't Thal and I'm Tracy. Tracy. I have
Speaker 1: a question about things in Hong Kong, which is, are
Speaker 1: people going crazy for stock trading there the way they
Speaker 1: are here? It's a good question. I'm not sure if
Speaker 1: this is reflected in Hong Kong, but definitely in mainland
Speaker 1: China We've had this massive rally in Chinese shares, So yeah,
Speaker 1: over there we're having like a similar retail boom to
Speaker 1: what we have seen in the US. Yeah, I mean
Speaker 1: it's pretty crazy. I mean that has been you know,
Speaker 1: there's a lot of like subplots to this crisis. In fact,
Speaker 1: that's sort of the theme of our podcast over the
Speaker 1: last several months, is just exploring all of the subplots.
Speaker 1: But the the incredible boom that we've seen in retail
Speaker 1: trading activity has to be one of the more surprising ones.
Speaker 1: And of course the whole you know, it's the whole
Speaker 1: robin hood phenomenon. All these people their home, they're not
Speaker 1: their jobs, there's no sports betting going on, and so
Speaker 1: it's like, all right, well I got a few bucks
Speaker 1: laying around, maybe I'll bet on some Tesla shares for
Speaker 1: free on robin Hood. Yeah. I think that's it, isn't it.
Speaker 1: It's it's not it's not necessarily that retail investors are
Speaker 1: jumping into the stock market. It's the way in which
Speaker 1: they're doing that. Because we have commission free trading now,
Speaker 1: you can kind of take a punt on a bunch
Speaker 1: of stuff without necessarily losing that much money, at least upfront,
Speaker 1: I guess. And like the punts that we are seeing.
Speaker 1: Tesla hurts switched to Clared bankruptcy. Everyone's been talking about those,
Speaker 1: and I think that really that really stands out right now. Yeah. Absolutely.
Speaker 1: I remember like last year, I think it was it
Speaker 1: was last year and Charles Schwab announced that who was
Speaker 1: going to cut commissions to zero, and a bunch of
Speaker 1: other online broker bridges followed suit, and my first though
Speaker 1: was like, oh boy, like, people are gonna lose a
Speaker 1: ton of money because they're gonna overtrade, and some people
Speaker 1: probably are. But the weird thing is that a bunch
Speaker 1: of people who jumped into the market over the last
Speaker 1: several months have actually participated in one of the most
Speaker 1: extraordinary rallies we've seen of all time. So for now,
Speaker 1: some people are clearly winning. Yeah, But the other part
Speaker 1: of the story is, I guess the downsides of retail participation,
Speaker 1: or not the downsides, but the criticism that comes along
Speaker 1: with it. So obviously a lot of people have been
Speaker 1: making fun of people who are buying Tesla stock or
Speaker 1: bankrupt company stock. We've also had some criticism of some
Speaker 1: of the trading platforms, but particularly robin Hood, which seems
Speaker 1: to be at the at the forefront of commission free trading. Right,
Speaker 1: robin Hood has sort of become it's kind of like
Speaker 1: become like the like band aid or Kleenex. It's like
Speaker 1: this brand, but it also is synonymous with a phenomenon
Speaker 1: or an industry, you where lots of people are getting
Speaker 1: into trading and this whole commission free retail craze it also,
Speaker 1: um you know, raises some questions in addition to just
Speaker 1: sort of the retail side, about how the industry is
Speaker 1: making money and who is really the big winner here,
Speaker 1: Because sure, there are some people that have probably turned
Speaker 1: a little bit of money into um, you know, millions
Speaker 1: thanks to investing in buying call options on Tesla, but
Speaker 1: also a lot of people are just are making a
Speaker 1: lot of money just handling this incredible order flow, this
Speaker 1: incredible activity. And obviously with commissions having gone to zero,
Speaker 1: the business model has changed a little bit safe from
Speaker 1: the late nineties when the online brokers say like charged
Speaker 1: just fourteen dollars a trade or whatever it was, right,
Speaker 1: so there's no free lunch and economics, there's supposed to
Speaker 1: be no free lunch when it comes to trading. But
Speaker 1: clearly retail investors are getting you know, commission free trades,
Speaker 1: and yet someone must be making money off of those.
Speaker 1: How are they doing it? Exactly? And again that kind
Speaker 1: of feeds into some of the criticism that we've seen
Speaker 1: around the robin Hood platform. Yeah, exactly right. So that's
Speaker 1: what we're going to dive into today, like who's really
Speaker 1: making money off of all this activity? How sustainable it is,
Speaker 1: what the new business models of online brokerage really look like.
Speaker 1: And so we're going to be talking to a great guest.
Speaker 1: He's actually with us at Bloomberg. He's the head of
Speaker 1: market structure research at Bloomberg Intelligence. Larry tab is joining
Speaker 1: us to explain the sort of the new retail online
Speaker 1: broken landscape. Who's making money out Larry, Thank you very
Speaker 1: much for joining us, Joe and Tracy. I'm really happy
Speaker 1: to be here. It's great to be here. Thanks. How
Speaker 1: surprising or weird is this moment? You've been examining the
Speaker 1: world of market structure for a long time. How crazy
Speaker 1: are things right now? From your perspective, that's pretty insane,
Speaker 1: you know, if you look at if you look at
Speaker 1: equity volumes. While we didn't hit a record during during
Speaker 1: February March, we you know, in terms of share volume,
Speaker 1: we pretty much almost doubled the amount of notional traded
Speaker 1: and that has a lot to do with the lack
Speaker 1: of stock splits. But um, the amount of value turning
Speaker 1: over is just phenomenal, given given traditional history, and even
Speaker 1: this is through the global financial crisis, through the dot
Speaker 1: com meltdown, the volume has just been astronomical. And and
Speaker 1: actually the other thing you got to go provide kudos too,
Speaker 1: is the market infrastructure. We really haven't seen now. Robin
Speaker 1: Hood was was down for a day or so, but
Speaker 1: other than that, you know, you've seen very few outages
Speaker 1: and and and given all the volume, and especially over
Speaker 1: a prolonged period, the brokers, the exchanges, the infrastructure providers
Speaker 1: have really done a great job keeping up with it.
Speaker 1: I mean, robin Hood was down at a pretty critical
Speaker 1: time in retrospect. But before we get into all of that,
Speaker 1: what do you think is driving through retail interest in
Speaker 1: stock trading at the moment. Is it as simple as
Speaker 1: everyone being stuck at home and having nothing to do,
Speaker 1: or is it people who saw the federal reserve response
Speaker 1: and assume that it would lead to a big rally
Speaker 1: in risk assets or is it something else. I think
Speaker 1: you've got a couple of different factors going on. First,
Speaker 1: I think the initial issue was a freak alpium that
Speaker 1: everybody realized that, hey, the the economy may come to
Speaker 1: an end, and you know, we might have this pandemic
Speaker 1: of global proportions that they kind of erect the economy.
Speaker 1: And so I think a lot of people got on
Speaker 1: sold a lot that you know, that would would explain
Speaker 1: a lot of the big dips and reallocate their portfolios.
Speaker 1: Then I think, you know, the economy started shutting down
Speaker 1: in mid March. People were stuck at home, there was
Speaker 1: no sports, there was no there was no nothing um
Speaker 1: and you still had a lot of volatility. And then
Speaker 1: I think you start getting into this whole you know,
Speaker 1: I'm stuck at home. What do I do? And then
Speaker 1: you've got also a lot of professionals that are also
Speaker 1: stuck at home with nothing going on and a lot
Speaker 1: of volatility. And then you start seeing things like Amazon. Oh,
Speaker 1: you know, I'm gonna go. I'm gonna go buy everything
Speaker 1: from Amazon. It's going to come the next day. So
Speaker 1: you've got logistics pops, You've got you online pops, and
Speaker 1: you've got the hotels you know, and entertainment sector shutting down,
Speaker 1: so you have a lot of interesting plays and thoughts around, hey, look,
Speaker 1: this sector may actually do really well, but the sector
Speaker 1: might actually do very poorly. So you've got some real
Speaker 1: directional bets. Whereas over the last decade it's really, you know,
Speaker 1: the secret to life has mostly been throw everything in
Speaker 1: the sp five and just let it grow. So now
Speaker 1: you actually have directional bets that you can play, and
Speaker 1: so I think you've got to You've got a whole
Speaker 1: bunch of factors. Plus, of course, you know, commission free brokers.
Speaker 1: We started to see the you know, in December, when
Speaker 1: we started to see Schwab and the other guys kind
Speaker 1: of throwing the talent commissions. You start to actually see
Speaker 1: the retail participation tick off. Actually, then it didn't just
Speaker 1: happen in February March. It really started December when when
Speaker 1: folks brought their commissions down to zero. Actually, I want
Speaker 1: to back up for a second. So we introduced you
Speaker 1: as the head of market structure research at Bloomberg Intelligence.
Speaker 1: But UM, talk to us a little bit about your background,
Speaker 1: but also market structure What does that mean? I don't
Speaker 1: know if like that term is a particular one that
Speaker 1: people have a grasp on when they hear it. And
Speaker 1: why is it something that itself should needs to be understood?
Speaker 1: Why why you should people know more about the sort
Speaker 1: of vague, big picture concept of market structure and why
Speaker 1: is it worth researching? Well, certainly my wife doesn't understand it,
Speaker 1: but market structure researches is basically not necessarily what people
Speaker 1: are buying and selling and whether IBM is expensive or cheap.
Speaker 1: It's how all of the infrastructure fits together. So it
Speaker 1: used to be, you know, we used to have a
Speaker 1: New York Stock Exchange floor and people wandered around and
Speaker 1: negotiated and we're specialists and floor brokers. Um. And then
Speaker 1: NASTAC was over the counter, mostly traded on traders desks.
Speaker 1: But over the last twenty years, basically all of this
Speaker 1: has been electronified. And so we now have thirteen fourteen
Speaker 1: exchanges soon to be sixteen exchanges. In US equities, we
Speaker 1: have sixteen options exchanges. And the pricing structure and how
Speaker 1: all this fits together and how do they connect and
Speaker 1: who do you route to first, and what types of
Speaker 1: orders do you put where? And how do you measure
Speaker 1: whether you're you're getting a good fill or not. That's
Speaker 1: all it has to do with all the rules and
Speaker 1: mechanisms the markets are engaged to actually match fib consellers together.
Speaker 1: And this occurs not just in U S dequities, but
Speaker 1: fixed income. You're starting to see electronification of the fixed
Speaker 1: income markets, and that's much more complicated and fragmented than equities,
Speaker 1: UM and foreign exchange and and so you're seeing the
Speaker 1: movement and the electronification of all of these markets, and
Speaker 1: it has tremendous ramifications in terms of how your orders
Speaker 1: are executed. And so that's that's basically what market structure researches.
Speaker 1: So it starts with the rules and regulations and then
Speaker 1: translates into how all of these rules from regulations are
Speaker 1: adopted through exchanges and and the market infrastructure. I gotta
Speaker 1: say I used to call Larry up quite a bit
Speaker 1: when I was writing market structure stories over at the FT,
Speaker 1: and he was always very generous with his time and insightful.
Speaker 1: So thank you, Larry. Um, let's connect the market structure
Speaker 1: argument to what's going on with the commission free brokerages
Speaker 1: or trading offers I mentioned in the intro. There's this
Speaker 1: weird thing. You're offering someone the ability to trade for free,
Speaker 1: but obviously that trade is generating a cost somewhere in
Speaker 1: the system. So how exactly are those trades being funded? Yes,
Speaker 1: so this is really an interesting topic, and so at
Speaker 1: the very highest level it sounds really fishy. Um, you
Speaker 1: mean that market makers and wholesalers are actually paying to
Speaker 1: execute against my trades as a retail broker there as
Speaker 1: a retail investor. How can that be good? They must
Speaker 1: know something that I don't know. They must be ripping
Speaker 1: me off, They must be giving, you know, getting me
Speaker 1: a horrible execution. Um, this can't be right. Actually, though,
Speaker 1: it's not necessarily as nefarious as it all sounds. And
Speaker 1: first of all, there are two different payment for order
Speaker 1: flow screens. First there's equities, which which works one way,
Speaker 1: and then there's options, which actually is a whole different
Speaker 1: way that's a little more challenging. What we can talk
Speaker 1: a little bit that about that if we have time,
Speaker 1: um the equity side, So think about equities and think
Speaker 1: about an electronic platform. So at the heart of an
Speaker 1: electronic matching platform that works in microseconds, and all of
Speaker 1: these exchanges now execute in microseconds, if not quicker than microseconds,
Speaker 1: basically hundreds of nanoseconds, which is an unfathomably fast amount
Speaker 1: of time. So me, as a market maker, what what
Speaker 1: am I doing? I'm putting out a bid the buy
Speaker 1: or sell Apple, okay, And and so all of these
Speaker 1: really smart, really high frequency trading firms are looking at
Speaker 1: my quote to buy or sell Apple and trying to
Speaker 1: determine if that's the appropriate price for this nanosecond basically
Speaker 1: for this microsect and if it's wrong, it's either not
Speaker 1: going to trade if I'm too high or too low.
Speaker 1: But if I'm too aggressive, I'm gonna get taken out
Speaker 1: in that in a heartbeat, in in the microsection. So
Speaker 1: me as a market maker, I have to you know,
Speaker 1: if I'm trading on lad exchanges. I have to ensure
Speaker 1: that I'm really confident in my quote, and confident in
Speaker 1: that my quote not just in terms of trace here
Speaker 1: Joe or Larry trading against that quote, but confident in
Speaker 1: that quote for a big, huge mutual funds, high frequency traders,
Speaker 1: and the smartest hedge funds in the world to trade
Speaker 1: against that quote. Um, because the second that i'm you know,
Speaker 1: are the microseconds that I'm wrong, I'm gonna get taken out.
Speaker 1: So the quote that I provide really has to be
Speaker 1: an institutional quote, a quote that that you know, hedge
Speaker 1: funds and mutual funds need to think, Okay, you know
Speaker 1: that's a fair quote, not too aggressive, not to to lose.
Speaker 1: That said, the reason why, um, they're thinking that is
Speaker 1: because they're trying to buy thousands of not hundreds of thousands,
Speaker 1: if not millions, of shares. You and I are are
Speaker 1: trying to buy a hundred shares are increasingly less than
Speaker 1: a hundred shares. But that's a whole another topic about
Speaker 1: AUTI loots to promote the title of this podcast, in effect,
Speaker 1: because you're in my order is for a fraction of
Speaker 1: the shares of Fidelity or Capital Group or Bridgewater or
Speaker 1: whoever's trying to buy, I can price you're in my
Speaker 1: order tighter because you know, because I don't have you know,
Speaker 1: because Larry doesn't have a million shares after that first
Speaker 1: hundred share share order behind it. So if you think
Speaker 1: about supply and demand, what does the market do? E
Speaker 1: gauges supply and demand, And if there's not a whole
Speaker 1: lot of supply or demand, then the price should not
Speaker 1: change that much um Whereas if there's a lot of
Speaker 1: supplying demand that the price will change a fair amount.
Speaker 1: But theoretically, actually retail trades should actually price more aggressively
Speaker 1: than than the larger orders. And that's kind of the
Speaker 1: theory behind aiming for order flow, that a market maker
Speaker 1: could actually priced mire your shares better then they can
Speaker 1: price a large mutual funder heads fund. And the savings
Speaker 1: that gets split three ways. It gets split up into
Speaker 1: price improvement, which basically means that they're gonna they're gonna
Speaker 1: give me the customer a better price. They're going to
Speaker 1: pay a few cents to the broker that the retail
Speaker 1: broker who were outed that water flow to them, and
Speaker 1: that's the payment for water flow part. And then the
Speaker 1: third part of course, is the wholesaler's profit. And so
Speaker 1: that is if you think about it, that that's that's
Speaker 1: the philosophy behind internalization and equity payment for water flow.
Speaker 1: All right, there's a lot there, So let's try to
Speaker 1: unpack it a little bit further. So you've made this
Speaker 1: distinction between say, if if me or Tracy you want
Speaker 1: to buy ten shares of apple Um, then the market
Speaker 1: maker at the other end can price you, said, I
Speaker 1: think more aggressively or give a so a narrower spread
Speaker 1: because they feel more confident. Yeah, because because you're not
Speaker 1: going to come on the back of that with another
Speaker 1: hundred another hundred an ad shares. So when Schwab last
Speaker 1: year announced that they were going to go commission free,
Speaker 1: everyone's like, yeah, well they can do it because they
Speaker 1: have this huge float of other assets and they make
Speaker 1: money in a bunch of ways. But that's obviously not
Speaker 1: the case with robin Hood, which doesn't have you know,
Speaker 1: which doesn't have nearly the asset base, that has a
Speaker 1: very different business model, that doesn't have the bank attached
Speaker 1: to it like Schwab does. It doesn't have all the
Speaker 1: R I, A, S, etcetera. So just let's walk through
Speaker 1: specifically the innovation on say the robin Hood side a
Speaker 1: little bit further and how payment for order flow works there.
Speaker 1: I opened up my robin Hood app. I make an
Speaker 1: order to buy ten shares of Apple. Explain to me
Speaker 1: specifically how robin hood makes money after that transaction without commissions. Well,
Speaker 1: they make them their their money pretty much the same
Speaker 1: way that swab are a merry trade or each trade
Speaker 1: you know, doing that trade, get is going to get
Speaker 1: routed to most likely Citadel, Virtue or Susquehanna through the
Speaker 1: city har E tr And just just to stop you
Speaker 1: real quickly when you those are the market makers when
Speaker 1: you were talking about Okay, so these entities like Virtue, Citadel,
Speaker 1: uh and so forth their market Suscohana their market makers,
Speaker 1: their market makers. Yeah, and so they're going to route
Speaker 1: that order flow to generally one of those three players.
Speaker 1: They're the three largest, and there are a couple of
Speaker 1: other auxiliary players there too, like six, like two sigma.
Speaker 1: So they're gonna wrote that order flow to those guys.
Speaker 1: The wholesalers are going to execute that equity order at
Speaker 1: we're better than the best price in the mark because
Speaker 1: that's how the SEC demands that those those orders get
Speaker 1: executed and they're gonna pay. They're going to probably give
Speaker 1: a little bit of price improvement to the order so
Speaker 1: that you'll get a price that it's actually better than
Speaker 1: what you see in the marketplace, and then they're going
Speaker 1: to pay robin Hood a few cents for that order.
Speaker 1: And it could be you know, it could be anywhere
Speaker 1: from the average payment for order flow is about fourteen
Speaker 1: cents per hundred shares, but actually in robin Hood it's
Speaker 1: it's more. Yeah, I wanted to I wanted to ask
Speaker 1: you about exactly this, and I think maybe it will
Speaker 1: help us understand the process more. But one of the
Speaker 1: criticisms of robin Hood especially is that it tends to
Speaker 1: get more for every dollar in you know, customer order
Speaker 1: flow versus someone like Schwab. Why is that? What's the
Speaker 1: difference there, because presumably everyone is sort of executing at
Speaker 1: at similar prices, or at least execut eoting with with
Speaker 1: the same intent of achieving best price. Yeah, that that
Speaker 1: gets a little square me. So, So if you think about,
Speaker 1: you know, the three sections of profit, you know, the
Speaker 1: price improvement, the payment for water flow, and the market
Speaker 1: maker profit. So if you think about it, the spread
Speaker 1: is going to be the same whether it's you know,
Speaker 1: whether you know it's you or me, are coming from
Speaker 1: Schwab or robin Hood or each free. So the bigger
Speaker 1: question is how much am I going to make on
Speaker 1: that trade? And how is that what I make going
Speaker 1: to be split between what I keep, what I send
Speaker 1: to the client and what I send to the broker
Speaker 1: and what I what I keep will probably be somewhat
Speaker 1: consistent because it's very competitive, and so the real differences
Speaker 1: between what I what I give to the client and
Speaker 1: what I give to to the broker. And and while
Speaker 1: they don't have, um the execution quality stats, that's where
Speaker 1: there could be different you know, um that robin Hood
Speaker 1: may keep a larger percentage or a smaller percentage, or
Speaker 1: give you a larger percentage back to the client or not.
Speaker 1: And that's where there can be some variability. How do
Speaker 1: you measure execution quality? Execution qualities usually measured by the
Speaker 1: spread and the percentage of the spread that goes to
Speaker 1: the market maker versus the percentage of spread that goes
Speaker 1: to the client. And and we've seen those numbers actually
Speaker 1: very significantly over the last twenty years from basically the
Speaker 1: broker or the market maker keeping the full spread, the
Speaker 1: only keeping roughly about of half the spread, actually keeping
Speaker 1: half the spread because everything is measured on half to
Speaker 1: spread between the midpoint and the execution price. So it's
Speaker 1: gone over the last twenty years from the market maker
Speaker 1: keeping basically the whole half spread versus they're only keeping
Speaker 1: about half the spread. And so it's all measured between
Speaker 1: the execution price and versus the displayed price. And it's
Speaker 1: a measurement called e Q effective over quoted ratio and
Speaker 1: that's part of the SEC's reporting requirements for retail execution.
Speaker 1: So we're seeing, you know, we're seeing much better execution quality. Now.
Speaker 1: That execution quality differs, you know, can differ really depending
Speaker 1: upon what the broker's priority is. Do they want to
Speaker 1: get paid or do they want to give that money
Speaker 1: to the client. So you can look at let's just
Speaker 1: say Fidelity. Fidelity doesn't take payment for water cloth from
Speaker 1: retail clients. So all of that, all of that money
Speaker 1: that comes back in effect from the wholesaler um goes
Speaker 1: directly to the client. Whereas folks like Robin Hood probably
Speaker 1: take a little bit more, Shub takes a little less,
Speaker 1: but you know, it really is a dialog most depending
Speaker 1: upon what what the pretail brooke will wants. So I
Speaker 1: want to press you a little bit on best execution
Speaker 1: and best price as well, because one of the criticisms
Speaker 1: of commission free trading or payment for order flow is
Speaker 1: that even though you're trading for free, you might not
Speaker 1: necessarily be getting the best price. And that's you know,
Speaker 1: even though you're dealing in smaller retail orders, um that
Speaker 1: market makers can execute at tighter spread. So can you
Speaker 1: can you sort of walk us through that argument? And
Speaker 1: what is what is the opportunity that retail investors are
Speaker 1: missing out on when their trade goes to a payment
Speaker 1: for order flow provider versus a different system. You're you're
Speaker 1: starting to get into a little complicated areas here, So
Speaker 1: let's let's make it a little let's make it a
Speaker 1: little simpler, and then we'll add some complexity to Generally
Speaker 1: what happens is since the wholesaler receives the order and
Speaker 1: executes it off exchange, they then can manage the risk
Speaker 1: and execute it and executed at a tighter price than
Speaker 1: you know what can happen on the exchange. So without
Speaker 1: the without the whole, without the wholesaler. In effect, what
Speaker 1: would happen is that order would go to an exchange
Speaker 1: and that would trade on the bid or on the offer, okay,
Speaker 1: or you know, if it traded in the dark, it
Speaker 1: might be executed at a mid price, but by and large,
Speaker 1: if it goes to an exchange, it's going to be
Speaker 1: traded at the bid or the offer. The whole saler
Speaker 1: is going to give you uh an inside price, a
Speaker 1: price that's better than the bid of the offer. So
Speaker 1: the whole idea that that the wholesaler is kind of
Speaker 1: ripping you off. That doesn't really fly, especially when you
Speaker 1: start seeing prices that are tighter than the best bid offer,
Speaker 1: because you wouldn't necessarily get that. If you routed to
Speaker 1: an exchange, you would generally get the bitter offer. Now,
Speaker 1: adding a little bit of complexity to this is that
Speaker 1: in most cases, odd lot orders are not displayed, and
Speaker 1: and that's part of the new SEC Market Data Infrastructure proposal.
Speaker 1: If they want to start seeing more odd lots, be
Speaker 1: part of the bit of the offer. So there may
Speaker 1: be odd lots sitting more aggressively in the market. Then
Speaker 1: then you actually see when you get on your robin
Speaker 1: Hood screen or your schwob screen, and so they're actually
Speaker 1: may be more aggressively priced orders out there that you
Speaker 1: can't see. But hopefully under the new UM proposal, if
Speaker 1: that ever goes through UM, you know you'll see a
Speaker 1: tighter price and a little different So I wish I
Speaker 1: could say that you were always when you've got price improvement,
Speaker 1: you are always getting UM the most aggressive price that
Speaker 1: you can get into an exchange. But that may not
Speaker 1: necessarily be true, depending upon the numbers share you're executing
Speaker 1: and what you actually can't see that's more aggressively priced
Speaker 1: because of the way that consolidated Tabeork. So I'm curious.
Speaker 1: So obviously, payment for order flow is UM available and
Speaker 1: widely used in the United States, but over in the
Speaker 1: UK the Financial Services Authority cracked down on it many
Speaker 1: many years ago. I think it was they banned it
Speaker 1: in Europe, Yeah, I think it was two thousand twelve.
Speaker 1: So what is it that they're seeing? What's their concern
Speaker 1: with it that, you know, the US isn't necessarily seeing. Well.
Speaker 1: First of all, retail trading in Europe tends to trading
Speaker 1: in Europe tends to be not as retail focused. A
Speaker 1: lot of the equity trading and shares trading in Europe,
Speaker 1: it was really done by more institutions, so that's that's
Speaker 1: one thing. Share trading in Europe in the UK by
Speaker 1: retail tends to be more around spread betting, which is
Speaker 1: illegal here, so so there are different types of retail
Speaker 1: brands actions that occur. The priority in the US has
Speaker 1: really been to get the retail investor the best price,
Speaker 1: and the SEC has structured those rules to really focus
Speaker 1: more on price then price transparency within the exchanges. Europe
Speaker 1: has been a little bit more focused on the whole
Speaker 1: idea that we're community and the exchanges are really the
Speaker 1: central point of price formation, and that that we want
Speaker 1: a larger proportion of orders and trades to go through
Speaker 1: the exchange infrastructure now and that was a part of
Speaker 1: what the MIFED to the Market and Financial Instruments Directive.
Speaker 1: Their second cut at that tried to do with with
Speaker 1: reducing the amount of flow that could be traded in
Speaker 1: dark pools and things like that. They were not successful there,
Speaker 1: so they'll probably be a MIFED three, but they try
Speaker 1: to push order flow into the exchanges. The US really
Speaker 1: cares more about the price that investors get then UM
Speaker 1: basically ensuring that the orders trade on exchange M. Can
Speaker 1: you explain a little bit further. You mentioned that, Uh, Fidelity,
Speaker 1: I think you said, didn't do payment for order flow,
Speaker 1: which broker? Yeah? For equities? Which ones uh do and don't?
Speaker 1: And what is the alternative model? Why not engaging it? Well,
Speaker 1: first of all, Fidelity has the large mutual fun complex FUM.
Speaker 1: I don't know for sure, but you can assume that
Speaker 1: fidelities you want payment for order club. If you think
Speaker 1: about it, if the retail orders did not go to
Speaker 1: the sellers, they would come into the market and overall
Speaker 1: they would be accessible to the institutions to trade against.
Speaker 1: So so if you look at Fidelity over over, you
Speaker 1: know its entirety, they want access to that order float
Speaker 1: into their mutual funds, which they're really not getting. The
Speaker 1: contra argument to that is that you know Fidelity, and
Speaker 1: I'm not just picking up Fidelity, but you know every
Speaker 1: mutual fund or every institutional trader, they hire traders, professional
Speaker 1: traders who use algorithms to study um you know, execution quality,
Speaker 1: who really focused on how they execute their waterflow, and
Speaker 1: that's what they get paid for. That's what you can
Speaker 1: pay your fees to cover UM, but who represents your
Speaker 1: order at Schwab, who represents your order you know, at
Speaker 1: each trade you can argue that that is the wholesale
Speaker 1: of the wholesaler you know, gives you that best price
Speaker 1: in effect, because they are the guy that's guaranteeing that
Speaker 1: best execution. And SWAB and those guys, they don't have
Speaker 1: those teams of traders studying every fill, every order UM
Speaker 1: and every nuance of transaction. So it's a it's a
Speaker 1: difference of philosophy that it's it's really it'd be great
Speaker 1: to say the payment for order flow is good or
Speaker 1: bad or this to that it's very nuanced and it's
Speaker 1: general life fall on that it's been. It's it's a
Speaker 1: good thing. We'll put it this way. The whole sailing process.
Speaker 1: Whether the firm like Fidelity gives all that money back
Speaker 1: to the client, I think that's a great thing. UM.
Speaker 1: I would much rather see um price improvement go to
Speaker 1: the client rather than the brokerags take a portion of it.
Speaker 1: But on the other hand, you know that payment for
Speaker 1: water flow along with securities lending, which is the other
Speaker 1: way that these guys make money. You know that that's
Speaker 1: you know what funds the ability to have pre commissions,
Speaker 1: so it's not like they're going to town on your
Speaker 1: order flow. It's a very competitive market and generally execution
Speaker 1: quality has just been getting better and better, so it's
Speaker 1: really this whole pros This has actually been good for
Speaker 1: individual investors um so. In addition to the big boom
Speaker 1: in retail trading, one of the recent trends that we've
Speaker 1: seen is all the banks reporting their results and a
Speaker 1: lot of them posting better than expected trading results. You
Speaker 1: mentioned internalization towards the beginning of our conversation. Could you
Speaker 1: maybe give us an overview of what internalization actually means
Speaker 1: at banks and how it it might be I guess
Speaker 1: how the business might be doing at the moment given
Speaker 1: that retail trading boom. There's been actually major shifts in
Speaker 1: terms of food trades and why if you look at
Speaker 1: our food trades and who profits. If you look at
Speaker 1: market share of you know, the over the counter business,
Speaker 1: it has shifted really dramatically to you know, to the wholesalers.
Speaker 1: Citadel Is trading like you know alone of all the
Speaker 1: overcount over the counter trades, and they have gained share
Speaker 1: over the last couple of months. Virtue um is less
Speaker 1: than them. I think they're in the you know or
Speaker 1: something range. And so you're seeing a tremendous shift of
Speaker 1: word flow to these wholesalers. The folks who are actually
Speaker 1: losing ground are, you know, the traditional brokers, the government's access,
Speaker 1: the Morgan Stanley's, the city groups, the Bank of American
Speaker 1: merrell Inches. They are losing, they have been losing ground
Speaker 1: in terms of equities, and and that's because a certain extent,
Speaker 1: it's very difficult for them to keep up with the
Speaker 1: technological race, the technology race, you know, compared to the Citadels,
Speaker 1: the virtues, the two stigmas, the Susquehannas, Because to certain
Speaker 1: extent you think about it, it's all about agility. If
Speaker 1: I can find a faster way, a faster server, a
Speaker 1: better way to calculate this stuff. If there were fewer
Speaker 1: levels of bureaucracy and technology layers between me and the
Speaker 1: ability to get you know, changed, I can adapt quicker
Speaker 1: and I can be more competitive. And if you look
Speaker 1: at the big banks, they've gotten so big and so
Speaker 1: large and and so so massive. So if so, if
Speaker 1: I'm in the equity trading side of big bank, a um,
Speaker 1: I'm competing for resources, not just with the fixed income side,
Speaker 1: and not just with the institutional side, but I'm competing
Speaker 1: for resources with retail banking, credit cards, mortgages, you know,
Speaker 1: wealth management, all sorts of different players. And so whereas
Speaker 1: if I am Citadel or Virture or Susquehanna, I just
Speaker 1: need to go across the floor and say, hey, body,
Speaker 1: I need I need a new server, you know, right,
Speaker 1: and you check, you see, and you've seen that play
Speaker 1: out as well as the regulatory infrastructure has not been
Speaker 1: particularly favorable over the last decade. That's the big banks
Speaker 1: in terms of taking risks. Now, on the other hand,
Speaker 1: you know, you look at the fixed income side, and
Speaker 1: you look at the earnings that the big banks have
Speaker 1: turned out on the fixed income side, you're probably looking
Speaker 1: at this quarter alone then making something like twenty to
Speaker 1: thirty billion dollars on their trading business. Now that twenty
Speaker 1: to thirty billion dollars is coming out of investors pockets,
Speaker 1: they are not making that kind of money on the
Speaker 1: equity side. And that has a lot to do with
Speaker 1: the market structure and the efficiency and the way that
Speaker 1: these orders are internalized in how they trade, and so
Speaker 1: over the time I think you're going to see the
Speaker 1: fixed income side become more efficient, probably will never be
Speaker 1: as efficient as the equity side, mostly because there's if
Speaker 1: it depending on if you include mortgages over a million
Speaker 1: queues of some million individual securities that need to be priced,
Speaker 1: but it's going to become more efficient and cheaper. Do
Speaker 1: you see these entities like Susquehanna and Citadel continuing to
Speaker 1: ex spanned their lines of businesses and just continue you know,
Speaker 1: I don't know if cannibalization isn't the right word, but
Speaker 1: find more areas where they can win market share against
Speaker 1: these legacy players, no question, no question. And so uh,
Speaker 1: you know, if you look at the you know, the
Speaker 1: markets that look closest to equities tend to be much
Speaker 1: more easily able to be you know, aligned to electronic
Speaker 1: trading type type strategies. So certainly options have gone that way.
Speaker 1: If you look at an exchange, it's it's starting to
Speaker 1: move in that direction. Some of the fixed income is
Speaker 1: starting to move in that direction. And it may not
Speaker 1: necessarily be the same players. Some folks have different you know,
Speaker 1: there are other players that focus in other markets, but
Speaker 1: the electronic guys are just they have lower overhead unless
Speaker 1: regulatory burdens. So it's a combination of agility focus and
Speaker 1: regulatory headwinds. And the banks over the last decade have
Speaker 1: certainly had tremendous amounts of regulatory headwinds in the size
Speaker 1: of the business. Before we go, I want to just
Speaker 1: go back to the robin Hood phenomenon. So you know,
Speaker 1: people hear this stuff like Citadel is paying for order flow,
Speaker 1: and they don't really understand what that means, and they're like, oh,
Speaker 1: you're you're being a front run, and that's really what's happening,
Speaker 1: And as you described, that's really not and in fact,
Speaker 1: actually pricing is pretty good and it just keeps getting
Speaker 1: better and better, and so forth, should be sec or
Speaker 1: regulators be more concerned about the gamification aspect. Of the
Speaker 1: gamification aspect, the idea that, uh, you know, these entities
Speaker 1: are sort of turning trading into a video game, and
Speaker 1: not so much whether people are getting bad prices are
Speaker 1: being front run, but whether this is just sort of
Speaker 1: like a risky, reckless way to introduced investors to the
Speaker 1: stock market. Now, now your ring on politics, um, you know,
Speaker 1: without oppinting on politics, but is this more the is
Speaker 1: this more the issue when people are like, something feels
Speaker 1: a little bit wrong about this, or I'm a little
Speaker 1: uncomfortable with this whole robin Hood thing. Is it more
Speaker 1: that side than the sort of more conspiratorial citadel stuff
Speaker 1: stuff like that? There there are there are significant issues
Speaker 1: there because if if now you can compare this pulls
Speaker 1: to the dot com crisis, when you started to see investors,
Speaker 1: you know, piling the pets dot com and things like that.
Speaker 1: This is different. Back then, it was really more about
Speaker 1: I p O s and buying and holding, and you
Speaker 1: wound up, you know, with kind of plaky companies being
Speaker 1: valued and wait too much and and people holding um
Speaker 1: all these overvalued assets and then all of a sudden
Speaker 1: the rug being pulled out. This seems to be a
Speaker 1: bit different and that this is more about trading. And
Speaker 1: I think one of the big things about robin Hood
Speaker 1: is the transparency of their platform enables you to kind
Speaker 1: of see what other people are trading and joined the
Speaker 1: momentum train. And the problem with that is that that
Speaker 1: you know, because you're dealing with a handheld device, do
Speaker 1: you have enough information to really understand if if you're
Speaker 1: in the beginning stages of this momentum train or if
Speaker 1: you're in the middle, or if you're really you know,
Speaker 1: buying at the peak. The benefit is that are they
Speaker 1: really investing a lot in each of these trades and
Speaker 1: are they how long are they sticking in with it?
Speaker 1: But there are certainly evaluation questions. But on the other hand,
Speaker 1: of the SEC doesn't look at itself because I'm trying
Speaker 1: to say, yes, we should allow you know, Larry or
Speaker 1: Joe or Tracy to buy Tesla whatever. They want to
Speaker 1: make sure that you know, when you buy a Tesla
Speaker 1: at whatever, is whatever the right price um and and
Speaker 1: it is there transparency around that. And so I don't
Speaker 1: see the SEC sticking their nose and the valuation issues
Speaker 1: that said people should be worried about the you know,
Speaker 1: the value of what they're buying because it's an effective
Speaker 1: that they're not really worried about it. Then you know,
Speaker 1: you're into the strategy of who's the next sucker who
Speaker 1: is going to buy this for me at a higher price?
Speaker 1: And I'm not sure that's great investing strategy right Well, uh, Larry,
Speaker 1: this is a great conversation. This cleared up a lot
Speaker 1: of questions that I've had for a while and sort
Speaker 1: of I think for me and Tracy gives us a
Speaker 1: lot of new avenues to explore. So I really appreciate
Speaker 1: you coming on and explaining it. I hope to play
Speaker 1: didn't confuse everybody too much, but it's it's not that.
Speaker 1: That's see, that's why we need market structure research because
Speaker 1: it is complicated. Thanks so much. It feels like we
Speaker 1: just scratched the service, but this was it was really great.
Speaker 1: Thank you, Thank you. Yeah. I have to admit tracing
Speaker 1: this area it does sort of hurt my head a lot,
Speaker 1: and I do have like a million more things I
Speaker 1: want to explore now. But that was a really helpful
Speaker 1: sort of overview of what is it kind of extraordinary
Speaker 1: moment in financial markets. Yeah, I mean I've read I've
Speaker 1: read the criticism, and I've read some of Larry's research
Speaker 1: which kind of argues that payment for order flow isn't
Speaker 1: as nefarious as it seems. And it's very hard for me,
Speaker 1: as a non expert to con you know, to come
Speaker 1: out on either side of that. But what I did
Speaker 1: find very interesting and something that I think we can
Speaker 1: all agree with was Larry's point about this idea of
Speaker 1: commission free trading sort of turning the market into a
Speaker 1: very momentum driven one. You know, people aren't necessarily holding
Speaker 1: for the long term because it doesn't cost them anything
Speaker 1: to make these trades, and so everything does really become
Speaker 1: about momentum or flows, you know, just guessing where the
Speaker 1: money is going to go in in next and one
Speaker 1: of our Bloomberg colleagues, Luke Kaw, did a really good
Speaker 1: story on robin Hood and this dynamic recently, and it
Speaker 1: was sort of around people kind of agreeing what stocks
Speaker 1: to buy and then pushing for them in online forums
Speaker 1: and then the stock would go up and they would
Speaker 1: make a lot of money on robin Hood through options
Speaker 1: trading and things like that. Anyway, That's that's the dynamic
Speaker 1: that that I think is very new and important for
Speaker 1: markets overall. Yeah, tell the right. I also like, um,
Speaker 1: we should have Chris White on again soon. I mean,
Speaker 1: I know we've had them on like nine times, but
Speaker 1: thinking about again revisiting this topic in light of just
Speaker 1: this massive quarter that the Wall Street banks had trading
Speaker 1: UH fixed income, we should definitely have them back on
Speaker 1: talking about market structure on that side too, because obviously
Speaker 1: there's a huge pot of gold there for anyone who
Speaker 1: is in a good position to, uh, you know, continue
Speaker 1: to disrupt that space like they've done with the equities. Hey,
Speaker 1: I am always up for a market's ructure episode. Great,
Speaker 1: well let's do more. So do we leave it there? Yeah?
Speaker 1: You know what I forgot to ask Larry. I wonder like,
Speaker 1: will we ever break the zero lower bound with brokerages? Like?
Speaker 1: Can I get someone will pay us? Yeah? Yeah, maybe
Speaker 1: that's the Maybe that's the next frontier. That'd be fun.
Speaker 1: You could you know, maybe make more money than you
Speaker 1: could on on interest rates by doing that? Yeah? Okay,
Speaker 1: I I meant to ask that, but next time, Okay,
Speaker 1: next time. All right, Well, this has been another episode
Speaker 1: of the All Thoughts Podcast. I'm Tracy Alloway. You can
Speaker 1: follow me on Twitter at Tracy Alloway and I'm Joe
Speaker 1: Why Isn't All? You could follow me on Twitter at
Speaker 1: the Stalwart, And you should follow our guests on Twitter
Speaker 1: Larry tab He's at el Tab with two Bees. Follow
Speaker 1: our producer on Twitter, Laura Carlson at Laura M. Carlson.
Speaker 1: Follow the Bloomberg head of podcast, Francesca Leave at Francesca Today,
Speaker 1: and check out all of our podcasts under the handle
Speaker 1: at podcast. Thanks for listening to