Why Do Brokers Who Do not Charge Payment for Order Flow Route Marketable Orders to Wholesalers?

Abstract

We present evidence that in May 2022 several retail brokers who do not charge wholesalers for their marketable orders routed most of their marketable orders to wholesalers for order handling and execution. Using proprietary marketable order flow data from one or more wholesaler(s) for May 2022, we evaluate several dimensions of wholesaler execution quality. As measured by reporting rules established by the Securities and Exchange Commission, we find that the wholesaler(s) provided about $78 million of savings to investors for the month. This swells to over $388 million including odd lot and short sell orders and the execution of large orders at better prices than an investor would have received if the wholesaler(s) simply executed these orders at order-receipt-time depth-of-book displayed prices aggregated across all exchanges. To better understand why brokers route orders to wholesalers, we conclude by conducting a “near-neighbor” analysis between executions on exchanges and “equivalent” marketable orders routed to the data provider(s). Ignoring access fees on exchanges, we find that seemingly identical trades received better prices from the wholesaler(s) in over 68% of the comparisons and equivalent prices in another 19% of the comparisons. When exchange fees are included, the wholesaler(s) win almost 91% of the time. We believe that this difference in execution quality supports retail brokers routing most of their marketable orders to competing wholesalers.

Keywords: Payment for Order Flow, Execution Quality, Order Routing, Liquidity

JEL Classification: G20, G24, G28