In China, regional exchanges are being forced out of existence by new government rulings, and are now going toward OTC multi-product electronic trading. Here is the full report, live from Hong Kong
A significant concern for Western OTC FX and CFD companies over the past few months has been the perceived interest by many of the large listed derivatives exchanges of London and Chicago in lobbying the global financial markets regulators in order to attempt to create sufficient weakness to their core product ranges that the only means of sustainability would be to place all retail electronic trading on centralized exchanges.
The recent proposals which were set forth by the Financial Conduct Authority (FCA) in the United Kingdom are a case in point, as the regulator stated its cause toward making substantial amendments to the method by which CFDs can be traded, that being a very popular product in Britain’s domestic market and a mainstream product offered by large, well established British firms.
Subsequently, an industry group was formed in London in order to work closely with the regulator to ensure that the bona fide OTC electronic trading industry is not affected unduly.
This move created a degree of very well founded concern, especially when considering the interest in moving into the retail market that the large listed derivatives exchanges have demonstrated via their merger and acquisition aspirations of late.
Recent activity in this direction that has given rise to suspect a lobbying effort by the old school tie brigade include CME Group’s recent investigation into the possibility of embarking on a project in which it provides a rolling spot contract, which if it went ahead would position it as a direct competitor to OTC derivatives companies.
Then there was the acquisition by Deutsche Boerse in July 2015 of FX trading platform 360T for $796 million. Now Deutsche Boerse is embroiled in its fraught merger with the London Stock Exchange, which has been deemed monopolistic by the European Commission, however that will proceed due to the imminent sale of LCH SA, the European division of LSE’s clearing division LCH.Clearnet as a condition of the transaction, whose buyers will be its largest customer.
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 in December, whereby Deutsche Börse will pay a US dollar amount in the single digit million range.
EUREX bought the 360T treasury system, 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 liquidity provision in an OTC trading environment vs the exchange traded products dynamics.
Most longstanding industry executives would find this type of direction sleep-inducing and not worthy of standing up against.
That is, until a long and close look is taken at the complete role-reversal that is taking place in China, and the massive opportunity for multi-asset FX brokers that should be taking advantage of it.
The counterparty credit risk aversion that many banks in the West have adopted recently has also created a deal of discourse.
Not so in China. Here at the Hong Kong Exhibition and Convention Center in Wan Chai, the second day of the iFX EXPO Asia 2017 FX industry conference is underway, produced by ConversionPros and industry news and research group Finance Magnates, optimism among the Chinese and Western senior executives reigns supreme, one aspect of which is manifesting itself in the opportunity for the OTC FX world to actually completely replace regional exchanges across China.
Today, FinanceFeeds met with Leverate CMO Nicc Lewis along with Andy Zhang, Leverate’s General Manager for China, who explained this in detail.
Mr Lewis posed a very poignant question, that being “Are you aware of what’s happening with the regulation of exchanges in mainland China?”
“The new rules state that only one exchange will be permitted per region. This means that there are a large number of highly experienced industry professionals which are now looking for a new business model, and this new business model will be OTC FX. We also believe that they will need some education and some hand holding to get over their initial fears, but they will take to FX en masse” said Mr. Lewis.
What are the fears and how can they be mitigated?
In the inevitable switch from operating exchanges to operating OTC electronic trading companies, Mr Lewis considers the largest fear among participants is the type of technology that they will now have to use, which differs tremendously from exchange technology.
“The technology for FX brokerages is more complex than that of a regional exchange” said Mr. Lewis. “There is a fear of technology and how to use the technology, especially for organizational matters such as risk management or the management of client assets” he said.
“Another concern is integration to live markets and how to manage relationships with liquidity providers” said Mr. Lewis.
Mr. Zhang added “With regard to handling client assets, concerns for those switching from an exchange model to a retail brokerage model do not just center around technology. The safety of the funds is a key matter because once running an FX brokerage, they will have to wire the money outside China, which is not as easy as in some other nations and is less transparent, whereas with exchanges, the funds are held locally with Chinese banks.”
“Regulation is a procedural matter that those establishing FX brokers will have to take on board also. With exchanges, local government regulation applies and is specific to that region, and is all in Chinese, with government oversight and control whereas with FX you need to get ASIC license, CySec regulation or an FCA license, all of which are very popular among Chinese clients and brokerages, but are ultimately overseas licenses and managing a setup like that would require a complete change in mindset, as well as caution.”
Indeed, whilst ASIC, CySec and the FCA are regarded highly by Chinese clients, there have been cases of the wrong type of licenses being issued to Chinese brokerages, hence concern in China.
From civil servant to entrepreneur
A clear observation is that when making a change that has been foist upon them by circumstance, many exchange operators are worried about having spent their career as government officials and now having to metamorphose into FX brokers and work abroad.
Mr. Lewis said “We believe that they will be looking for a reputable vendor and supplier to work with, and if we can provide the right full solution that is comprehensive and actually work with them through every aspect from within China, this will make matters much more organized.”
“My observation of the Chinese business people is that they are very pragmatic indeed. If something is working today they’ll be happy to do what works today, and if it does not work they will look for something else and put lots of resources into structuring it and getting it right” – Nicc Lewis, CMO, Leverate
IBs or brokers?
Mr Lewis concurs with FinanceFeeds opinion that the larger exchanges will want to keep the business themselves, hence they will establish as a broker-dealer and not take their existing clients and become an IB of a large overseas OTC FX brokerage.
Mr. Zhang then added “You are right, however there is another aspect to this, which is that in many cases IBs can only get commission from volumes or profit and loss, whereas exchanges, if they are large and run properly, are central and do not get money from client loss so their operators won’t want to go down that route.”
Indeed, we are all aware that there are some small pseudo-exchanges in China which are not exchanges at all but actually are b-booking all orders, but these are not the entities we are discussing today.
Mr. Lewis said “An exchange operator that has fallen foul of the new rules and is now entering the FX market can take a full end-to-end broker solution all provided in one package, that is hosted and operated completely from within China, and if they want to take a CySec license they can also take our LFS license.”
Interestingly, unlike many of the OTC FX establishment in China which is now gargantuan and is mostly comprised of IBs which are operating managed portfolios that are traded automatically via EAs on multi-account platforms, FinanceFeeds asked Mr Zhang if he considers a difference between that and the new clients that will come to FX from exchange, as they are both completely different businesses.
Mr. Zhang said “In this case, there will not be any EAs as there is within the managed portfolios handled by many IBs in China. Most retail clients in this case will be manual traders, as they came from exchanges and are used to trading themselves.”
Multi-asset is the byword for success in China
Many avantgarde retail FX firms are now realizing that the only way to succeed and future-proof themselves is to go fully multi-product across a combination of spot FX, and OTC and exchange listed products on one platform. When asked if this is the direction Leverate will take in China, Mr. Lewis explained “With Leverate system, clients have a combination of exchange-listed and OTC assets.”
Indeed, liquidity will be provided by international prime brokerages that have representation in China and vast levels of experience, such as Sucden Financial, LMAX, Advanced Markets and Saxo Bank just to name a few.
“For example, clients can trade A50 stocks as well as spot FX on the same platform. We have had it for a year and a half and it is a multi-product system. We already have big brokers in China that want liquidity on commodities so therefore this is an ideal fit for customers of regional exchanges that are now requiring a new system” said Mr Lewis
With regard to the future that OTC electronic trading will have and the need to innovate and develop a full scale multi-product market, Mr. Lewis said China has always been a multi-asset market. Brokers must come with an offering that offers both stocks and indices as well as FX, and will also need STP liquidity for all which is what makes the convergence between exchange and brokerage.”
Image: KK Tower, Shenzhen, China. Shenzhen is a booming 2nd Tier development town with a massive FX industry, and is on Hong Kong’s doorstep. This is one area that will certainly be a land of opportunity.
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