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There are other ways wholesalers exert power over the exchanges. Let's revisit your Robinhood order routed through CitSec. Imagine CitSec chooses CBOE to execute its order. CitSec enters the market and says "I've got an order that needs filling, who can give me the best price?"
What happens next is called a "price improvement auction". MMs will compete to win the auction by offering a price at or better than the NBBO. CitSec has a separate entity that will compete w/ other MMs for the order. Order by order competition? That's great! Well… not quite.
Because CitSec is the wholesaler their on-exchange affiliate has an advantage over other MMs. Exchanges charge them 1/10th the fees as a reward for bringing the order to their exchange. With 10x the fee hurdle, many MMs can't compete.
There's also the specialist angle to consider. Exchanges choose MMs to act as a specialist for each traded stock. Specialists have higher quoting obligations & in return get even more order flow exclusivity. Who are the top specialists? You guessed it - the top wholesalers.
So to review, wholesalers pay brokers for order flow & to manage their routing obligations. Exchanges pay wholesalers & give them special trading privileges for their order flow. Double the PFOF, double the fun! What happens if it's banned?
In my opinion, not much would change at first. Brokers would still route to wholesalers because they don't want to deal with exchange connectivity & routing. They just wouldn't be getting paid PFOF anymore. Wholesalers would CLEAN UP in this scenario.
Complex exchange connections & rules have given wholesalers a way to insert themselves in the flow of options volume & control immense amounts of power, more so than equities. Banning PFOF won't immediately take that power away. We can't look solely at equities to make policy.
Thanks for reading - hopefully you learned something from this thread. I'll be doing a deeper dive into options market structure in an upcoming post - sign up below if interested:https://frontmonth.substack.com/
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