Robinhood CEO defends payment for order flow, says practice is ‘here to stay’
Vlad Tenev, co-founder and CEO of Robinhood, rings the opening bell at the Nasdaq on July 29, 2021.
Source: The Nasdaq
Robinhood CEO Vlad Tenev says he doesn’t believe that the payment for order flow (PFOF) model of market-maker routing that the company incorporates in the U.S. is under threat.
That’s despite calls from notable consumer trading advocates and regulators for a ban on the practice.
Speaking with CNBC, Tenev defended the practice of PFOF, saying that it’s “inherently here to stay.” He was referring to PFOF as it exists in the United States, where the practice is legal and regulated.
PFOF is the practice of routing trades through market-makers like Citadel Securities in return for a slice of the profits. The phenomenon has helped trading firms like Robinhood drive commissions down to zero, making it cheaper generally for consumers to invest in stocks.
“If I’m a business that’s selling things, and I’m generating transaction revenue, the more you use it, the more money you get. Inherently, there’s a conflict there because I make more money by getting you to transact more,” Tenev told CNBC in an interview.
“I think it’s important not to take the baby out with the bathwater. What does that mean, you shouldn’t make revenue on a transaction-based business? That’s unreasonable. And I think the point has been politicised to some degree.”
PFOF is viewed as controversial because of the perceived conflict of interest it creates between the broker and clients.
Critics say that brokers have an incentive to direct order flow to market makers offering PFOF arrangements over the interests of their clients.
PFOF is banned in the U.K., where Robinhood announced plans to launch Thursday.
The U.S. Securities and Exchange Commission had looked at banning PFOF in light of concerns surrounding the practice, but opted not to, while the European Union has imposed a blanket ban on PFOF.
PFOF accounts for a small chunk of Robinhood’s revenues today, Tenev said, while much of its income today comes from net interest income which is generated from cash in user balances.
Transaction-based revenues, which includes PFOF, decreased 7% in Robinhood’s second fiscal quarter to $193 million.
“If you look at equities, PFOF in particular, it’s about 5%. of our revenue, so a much smaller component of the overall pie. And we’ve diversified the business quite a bit,” including other areas like securities lending, margin, and subscriptions.
Robinhood’s race to the bottom on commission fees has forced many major players in the wealth management world to slash their own fees to zero, in turn causing some companies to wind up or sell up to competitors.
TD Ameritrade was sold to Charles Schwab for $26 billion, while Morgan Stanley bought E-Trade for $13 billion.
“In the U.S., Robinhood came along and really changed the industry,” Tenev said. “The discount brokers that are charging commissions essentially ceased to exist.”
“They had to drop commissions to zero. A lot of them couldn’t survive that transition as standalone companies and ended up consolidating. And we’re still living through the the end result of that.”
Technology
Blip, dip, pullback or the beginning of the end? Global investors weigh in on stock sell-off
Global investor sentiment for artificial intelligence remains buoyant, despite on the ongoing stock sell-off.
European and Asia markets have seen days of consecutive losses, tracking their U.S. counterparts lower as pressures mount on AI-related stocks and their valuations. The pan-European Stoxx 600 on Tuesday notched its lowest level in a month, with major bourses opening mixed on Wednesday, while Asia-Pacific markets fell.
Stateside, stock futures were little changed overnight after major U.S. indexes extended their losses. AI-related stocks such as Nvidia, Palantir, and Microsoft are among those feeling the pressure.
“We do think this is an AI specific pullback. We don’t think this is the beginning of the bear market,” Emma Wall, head of investment analysis at Hargreaves Lansdown, told CNBC’s “Squawk Box Europe.”
When considering whether this is the “beginning of the end” or a moment marking “the big pullback,” Wall argued that while we are overdue a “major global market correction,” the current downturn is yet to bring this shift.
Many markets outside of the U.S. — particularly in Europe and the U.K. — already reflect much of the negative news, she said, adding that she sees the pressure as sector specific.
It is, however, an opportunity to rebalance portfolios, as “even taking into consideration this week, most people have had a really good run, even in AI stocks,” Wall said.
Mike Wilson, chief U.S. equity strategist and chief investment officer at Morgan Stanley, echoed this sentiment. He said markets have been in a correction for the past six weeks but “it’s not the end of the AI cycle.”
All eyes are on Nvidia, considered the bellwether of AI, as it’s due to post third-quarter earnings after the closing bell on Wednesday.
“Whatever happens tonight is, if it is a blip, is a pullback, it’s probably a dip to be bought. But I think we are in the midst of somewhat of a correction right now,” Wilson told CNBC’s “Inside India,” adding that he thinks it’s the middle-inning.
“The credit part of this spending is just beginning, meaning we’re just starting to raise money in the credit markets. It’s not like that money is going to sit there and they’re not going to spend it, which means there’s probably time on the clock with these intermittent kind of pullbacks,” he added.
Companies and investors are engaged in a delicate dance.
On one side, AI labs and their partners are making big promises and aggressive plays, according to Jason Thomas, head of global research and investment strategy at Carlyle. “But it’s not incumbent upon investors to believe them,” he told CNBC’s Julianna Tatelbaum, from the firm’s annual conference.
“Investors, of course, have to ensure that they are getting compensated for the risk that things don’t work out quite as planned, and I think that there’s a sense that perhaps there’s been some assets in the space that have been priced to best case scenarios. So I think that that’s the reassessment that’s going on right now,” he said.
Hyperscalers’ rising capex
The sell-off comes as the pace of debt dealmaking picks up, fueling speculation that it may have unsettled investors, many of whom have remained bullish on AI as long as companies post sound earnings. Google-owner Alphabet and Meta have issued bonds, for example.
“It’s not a problem, as long as the funding markets are there, meaning they’re raising the debt,” Wilson added. “I mean, there’s investors lined up,” he said.
It does however, become a problem when this is no longer the case, but “we haven’t seen that yet,” he said.
AI has fundamentally changed the strategy for many Big Tech firms, particularly when it comes to U.S. hyperscalers, which have morphed into capex-heavy companies from once asset-light businesses. Global investors are now assessing this new dynamic. Bank of America‘s latest Global Fund Managers Survey found that, for the first time in two decades, fund managers are concerned about hyperscalers “overinvesting.“
“[Hyperscalers] traded at very high price-to-book ratios, which made a lot of sense. You don’t value a money-printing machine based on the cost of the paper or based on the cost of the printing press. And that’s essentially what they were, these massive money printing machines where most of their assets were intangible, proprietary technology, the digital platforms,” said Carlyle’s Thomas.
“Now they’ve actually started to invest so much that 70% of their cash flow is being consumed by capital spending and, if you look at their book value now, 70% actually consists of property, plant and equipment, largely data centers. That’s a four-fold increase from a decade ago,” he added.
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