Citadel accounts for 22% of Robinhood’s PFOF revenue in 2021
Robinhood Markets Inc (NASDAQ:HOOD) has filed its annual report for 2021 with the Securities and Exchange Commission (SEC), with the document shedding some light on Robinhood’s revenue sources.
Robinhood derived transaction-based revenues from individual market makers in excess of 10% of total revenues, as follows:
- Citadel Securities: 22%;
- Tai Mo Shan Limited – 15%;
- Entities affiliated with Susquehanna International Group, LLP – 12%
- Entities affiliated with Wolverine Holdings, L.P. – 10%.
Let’s note that Robinhood’s business relationship with Citadel has been at the heart of the antitrust tranche of a multi-district litigation concerning the January 2021 short squeeze.
In the latest SEC filing, Robinhood confirms that the majority of its revenue is transaction-based, in that it receive consideration in exchange for routing its users’ equity, option, and cryptocurrency trade orders to market makers for execution. With respect to equities and options trading, such fees are known as payment for order flow, or “PFOF.”
Robinhood explains that its PFOF and Transaction Rebate arrangements with market makers are a matter of practice and business understanding and not documented under binding contracts. If any of these market makers were unwilling to continue to receive orders from Robinhood or to pay itfor those orders (including, for example, as a result of unusually high volatility), Robinhood might have little to no recourse and, if there are no other market makers that are willing to receive such orders from it or to pay it for such orders, or if Robinhood is unable to find replacement market makers in a timely manner, its transaction-based revenue would be negatively impacted.
This risk is particularly heightened for cryptocurrencies because fewer market makers are currently able to execute cryptocurrency trades. Furthermore, if market makers decide to alter Robinhood’s fee structure, its transaction-based revenue could significantly decrease. PFOF practices have drawn heightened scrutiny from the U.S. Congress, the SEC, state regulators, and other regulatory and legislative authorities.
For example, in November 2018, the SEC amended its rules relating to broker-dealer disclosure of order handling and routing to require that, among other things, such public disclosures must now describe additional detail regarding terms of PFOF arrangements and profit-sharing relationships that may influence a broker-dealer’s routing decision, including information about average rebates the broker received from, and fees the broker paid to, market makers.
In December 2020, Robinhood settled an SEC investigation into its best execution and PFOF practices and is defending putative class actions in federal district courts relating to the same factual allegations. Additionally, Robinhood’s PFOF practices were the subject of a line of critical questioning during a February 18, 2021 U.S. Congressional hearing related to the Early 2021 Trading Restrictions.
The company also faces a risk that the SEC, other regulatory authorities, or legislative bodies might adopt additional regulation or legislation relating to PFOF practices as a result of such heightened scrutiny or otherwise, including regulation that could substantially limit or ban such practices, or pursue additional inquiries or investigations relating to PFOF practices.
For example, a bill to direct the SEC to study and consider banning or limiting PFOF in the form of exchange rebates or payments from market centers to broker dealers, conflicts of interest based on PFOF arrangements, and the impact of PFOF on the quality of order execution passed out of the House Financial Services Committee in July 2021. In an August 2021 interview, Gary Gensler, Chair of the SEC, commented that a full ban of PFOF was “on the table.”
Because some of Robinhood’s competitors either do not engage in PFOF or derive a lower percentage of their revenues from PFOF than it does, any such heightened regulation or ban of PFOF could have an outsized impact on Robinhood’s results of operations. Furthermore, depending on the nature of any new requirements, heightened regulation could also increase Robinhood’s risk of potential regulatory violations and civil litigation, which could result in fines or other penalties, as well as negative publicity.