Hornblowing by the old guard appears to be the latest means of attempting to gain a seat in the very upper echelons of the OTC world
During the past few months, an apparent lobbying attempt by the large listed derivatives venues has become a point of conversation and supposition among the retail FX industry’s senior executives in major financial and electronic trading centers globally.
Although at first glance this would appear somewhat extreme, there have been several occurrences and corporate decisions within the boardrooms of large exchange-traded derivatives providers that have been somehow echoed by proposed regulatory directives which aim themselves firmly at the highly effective and successful OTC sector, especially in London, Sydney and Frankfurt, that it would be somewhat churlish to dismiss as paranoia.
High value corporate interest in entering the retail FX industry by listed venues has recently coincided with regulatory proposals which seek to impinge upon core business activities of three-decade-established OTC electronic trading firms, manifesting themselves in the publication by the Financial Conduct Authority (FCA) in Britain of consultation paper which detailed its proposals to restrict the method by which contracts for difference (CFDs) are provided to retail customers in December last year.
Similarly, ASIC in Australia and BaFIN in Germany, both regions with a longstanding CFD trading customer base, loyal to British companies and local branches of said British companies, have also demonstrated restrictions, with BaFIN having just two days ago issued a General Administrative Act, restricting the offer of contracts for difference to retail clients.
The document gives CFD brokers three months to adjust their business models to the new requirements, that is, they have until August 10, 2017, to comply.
As previously reported, the regulator is restricting the marketing, distribution and sale of CFDs with additional payments obligation. These will no longer be available to retail clients in response to concerns of unlimited losses and substantial risks that investors face when the difference to be paid exceeds the capital they have invested, as investors must pay the difference amount from their other assets.
While the German regulator insists that such a measure would enhance investor protection, FinanceFeeds has examined the matter in detail too, with such a step seen as a means to encourage the b-book execution model.
Why would they do that?
A close look at the mergers and acquisitions activity that has taken place among derivatives venues demonstrates two very important factors. The first is that the exchange venues, with their archaic modus operandi, and very expensive membership and clearing fees, are unable to maintain pace with technological advancement in terms of connectivity to live markets, platform responsiveness and ergonomics, and are way behind the prime of prime/prime brokerage price feed aggregation system used in OTC markets to bring efficient, live and real time trading environments to retail customers with far less latency than if a spot transaction was attempted via an exchange (the vast majority of exchange listed FX is futures – see Click 365, ICE, CME Group and Phillip Capital’s main volume generators in FX).
The second factor is that during the past two decades, the OTC sector has become so finely honed that it leads the way in terms of financial markets innovation, has garnered a longstanding and loyal retail customer base, often in domestic markets – most British CFD firms have 75% of their client bases within Britain – and the exchange sector is unable to gain its retail traders back via standard market competitive means.
The only methods that have been available to the giants of Chicago, Frankfurt and London in the exchange and equities sector has been through lobbying the regulators, and through aggressive mergers and acquisitions of FX specialists.
One of the first examples of this was CME Group which has been looking at a project whereby it comes up with a rolling spot contract which is a direct competitor to OTC derivatives firms.
Hotspot FX, one of the world’s most renowned OTC FX ECNs was bought by BATS Global Markets for $365 million in January 2015. It is also important to look at EUREX’s direction in which by September this year, the venue had extended its listed FX Futures and Options portfolio to include six new currency pairs while the overall minimum block trade sizes was reduced across all currency pairs to further improve hedging opportunities.
FinanceFeeds is also aware that this has been a focus for Deutsche Boerse for some time. Back in 2011, Deutsche Boerse took a minority stake in British FX technology solutions provider Digital Vega which was a technology vendor to buyside and sellside firms in the OTC derivatives sector.
At that time, the idea was to increase Deutsche Boerse’s positioning in the provision of pre-trade price transparency in the derivatives area for institutional investors and taking an initial footprint in the FX derivatives space. An investment agreement was signed last week, whereby Deutsche Börse will pay a US dollar amount in the single digit million range.
Deutsche Boerse bought 360T with the intention of moving the entire FX structure from an OTC bilateral system into an exchange clearing structure in my view. Another example of equity exchanges moving into FX was NASDAQ which wanted to launch NASDAQ FX but were unable to do so as they failed to understand the nuances of liquidty provision in an OTC trading environment vs the exchange traded products dynamics.
This is very important to note because Deutsche Boerse is one of the most notable aggressors in this dynamic.
In February this year, Deutsche Boerse CEO Carsten Kengeter faced a massive grilling from market analysts and investors over his alleged insider trading and on what grounds he has any remit to move the HQ of a merged entity between LSE and Deutsche Boerse to Frankfurt. Cartels, clearing and margin pool monopolies, undercapitalization, politics and an eye on the OTC world remain major concerns.
The venue made an increase in net revenues by 8% during 2016 compared with the previous year, and its operating profit increased by 18% however the traditional derivatives exchange is embroiled in insider trading scandals and also has been taking a viscious look at how to, along with the London Stock Exchange should the merger go ahead, avoid any accusations of creating a monopoly, whilst actively position itself as a factor in the lobby toward forcing OTC business onto exchanges.
Today, the firm is once again pushing its focus on OTC FX.
In a corporate statement that cannot be substantiated, the firm claims an all time high for daily overall trading volumes on its FX ‘powerhouse’ 360T.
Trading volume propaganda can never be substantiated, as there are several ways to report volumes, including double-counting, hence they are nothing more than PR and are very often misleading, which is why FinanceFeeds does not report them.
Today’s non-substantiable claim by 360T that it has generated record volumes for FX sets the scene for the real agenda, that being to attract interest to its new FX ECN.
“As a key element to the strategy, 360T launched its undisclosed marketplace (ECN) in April this year. The launch of the ECN is another significant step forward in the execution of our joint FX strategy” said Carlo Kölzer, CEO of 360T this morning.
The ECN enables access to additional liquidity and trading styles and adds another complimentary execution mechanism to the OTC FX trading offering. The underlying credit facilitation models are highly scalable and innovative, which enable an easy and efficient participation in the 360T ECN.
Carlo Kölzer further stated: “With the introduction of 360T ECN, our clients can take full advantage of accessing the entire variety of liquidity. Considering new regulatory and capital requirements, our ECN is the right solution for the future FX ecosystem, including the facilitation of the credit mitigation. 360T and Deutsche Börse Group are servicing the market participants with the most holistic offering in the market, with a combined OTC and Listed product range which will also enable liquidity to float from the listed market into the OTC market and vice versa.”
Considering Deutsche Boerse’s aforementioned interest in 360T and the reason for purchasing it and positioning it as Deutsche Boerse’s FX venue is clear. Without such a dedicated OTC component, it would not be able to compete.
Hornblowing by the old guard appears to be the latest means of attempting to gain a seat in the very upper echelons of the OTC world.
Image: Royal Exchange Buildings. London. Copyright FinanceFeeds