How brokerages make money - or why payment for deal flow is OK

Payment for order flow (POF) is banned in the UK as of 2012 by regulators citing conflict of interest:

POF is basically where a broker, lets say Hargreaves Lansdown, takes a client’s orders, and sells them to a market maker , lets say the london stock exchange (technically the LSE isnt a market maker, they just work with them, but lets keep things simple) for a fee. LSE/market makers then pocket the difference between the buying and selling price ( the “spread”) on that client’s order. Very shady business.

Trouble is, brokers are supposed to execute orders based on what gives the fairest price, but POF incentivises them to just sell their orders to whichever market maker pays them the most, leaving the everyday investor paying an unfair price. POF is still legal in the US for now, and is how Robinhood make most of their money, infamously so. Whats also messed up is not everyone. It’s all quite interesting stuff, POF, and poses the broader question of how lucrative, or even viable, a zero commision broker could be in the UK, or just anywhere markets are or will be tightly regulated.

If Freetrade (FT) ever reject your order, it’s probably because they’re trying to get you a fair price and couldn’t. whereas the less ethical brokers (literally everybody else) probably would have just went “f*** them lol”. There are still a few challenges before we have fairer markets, but as freetrade grows, and stock exchanges innovate(still waiting for a decentralised stock exchange tbh), I expect we’ll have even fairer prices. Now that I think of it, visible bid/offer spreads would be a great app feature in line with FT’s transparency… vote here