Providing institutional liquidity from Western markets to Chinese exchanges and creating Chinese prime brokerages for OTC trading is the way forward as the IB model’s nadir will provide the basis for an explosion of B2B opportunity. Here is how to do it
The Chinese retail FX industry is burgeoning.
We have all heard that before, several times, however, as FinanceFeeds as categorically emphasized during the course of the past few months as a result of in-dept research conducted in the world-dominating People’s Republic, this year will represent the very first time that the growth and development of the entire electronic trading ecosystem in this futuristic and leading edge nation will no longer be reliant on having a retail audience one side of the firewall, and the entire system that serves them including execution, client money and market connectivity on the free market side of the firewall.
The traditional and towering network of introducing brokers across China that have been of tremendous interest to Western brokerages for quite some time, with only a handful of large, high quality firms having been able to have garnered any long term and deep rooted business with the most important partners in China, is now ready to move away from being an introducing broker network and toward being a large scale brokerage ecosystem in its own right.
Gone are the days of small to medium brokerages attracting business from mainland China. The only way in 2017 is to have full Chinese operational presence. This applies to brokerage facilities, use of media, hosting and payments.
Nowadays, gone are the small IB channels which involve a representative with a relationship with local traders sending their funds to an overseas brokerage.
Today’s Chinese retail FX trader is astute, often extremely well-heeled, and in many cases, especially in second tier development towns such as Shenzhen and Zhengzhou, has multi-million dollar commercial real estate ventures and vast derivatives portfolios being funded by the monthly profit from lease agreements on vast illiquid assets such as mutli-storey apartment towers or shopping and leisure complexes.
Most certainly, the introducing brokers that adorn the second tier provincial development towns of the mainland are not only vast in terms of the assets under management that they are responsible for, but in many cases are larger than many western brokerages, and in some cases far more business orientated and have a very comprehensive knowledge of the component system of the FX industry.
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, and hosting a vast number of senior executives from Western and Chinese benchmarks in FX industry experience.
This afternoon, FinanceFeeds met with Biyi Cheng, Head of Greater China at CMC Markets to discuss the imminent transformation of introducing brokers to brokerages in their own right and how China is heading in the direction of becoming home to what is likely to be the world’s largest and most important self-sufficient institutional and retail FX ecosystem.
Mr. Cheng’s provenance is a case in point. His commercial background in the electronic trading industry spans across mainland China and the West, having begun his career in 1999 at the Bank of Communications in Shanghai as an interbank FX trader. Following that, he completed his Masters of Commerce degree at University of Sydney, and has subsequently resided in Australia for fourteen years.
Following graduation, Mr. Cheng joined CMC Markets as a dealer, based in Sydney and continued within that position between 2005 and 2010. In 2010 he moved to City Index as Head of Dealing for the Asia Pacific region, based in Sydney, before rejoining CMC Markets a year and a half ago following the company’s acquisition by GAIN Capital.
China and its integral relationship with large Western institutional firms
Mr Cheng explained to FinanceFeeds today that currently the retail electronic trading sector in China can be divided into just a few categories, those being largely centered around fund management and stock broking, and within those sectors, the companies offering such services are are single business and single product orientated, however now they want to make the change toward becoming multi-product providers and want to offer their prices on various assets.
“All of the fund management and stock broking companies are Chinese companies but they have traditionally only really been focused on the domestic market, but these days the senior management that operate these companies have the ability to undertand and operate in overseas markets” said Mr. Cheng.
“Chinese companies dominate outside China as well” he said.
“One of the reasons for this is that their customers want to trade asset classes based on overseas venues, largely down to uncertainty with regard to government policy and impending regulations, however they are willing to try to go to the overseas markets and do not have a risk averse approach when it comes to completely new business oportunities which gives CMC Markets institutional product good opportunity to connect with that type of traditional Chinese institution in order to bring our range of assets to a Chinese audience, via completely Chinese and long established domestic market venues” – Biyi Cheng, Head of Greater China, CMC Markets
CMC Markets widely recognized as an intriniscally British company with a large percentage of its retail audience being based in Britain, however the company’s institutional entry into China demonstrates the absolute necessity to adapt and develop specialist institutional solutions that will power the largest market in the world, on a completely business-to-business basis.
“Currently, there are many products traded on exchanges across China, most of which are owned by the government and in many cases, the smaller regional exchanges now face extinction because the Chinese government is passing a law that will allow only one exchange to be licensed in each region” said Mr. Cheng.
“The available products are usually commodities, gold, and in some cases exchange-traded futures exchanges, but the number of products is very limited and the pricing is firmly restricted to the sealed (government restricted) market and not part of the the open market” said Mr Cheng.
“Now, the ability for external providers to get into the market has arisen, largely due to many Western companies having learned the structure of the Chinese business environment. Those who approach this correctly will be able to generate a mutual benefit by trading on the products offered by exchanges whilst at the same time ensuring that Chinese exchanges are able to offer products which are provided by CMC Markets” explained Mr Cheng.
“Through this process, the exchanges will understand how to offer their asset classes to a global audience whilst offering global products to their existing Chinese audience without having to alter the structure of their physical operations. They will quickly understand how to do this in an oveseas market in a mature environment and with providers that understand the corporate culture of doing business in China. This therefore is beneficial from an international culture perspective” said Mr. Cheng.
Let’s elaborate on why Chinese institutional business is unique
“A lot of well established financial institutions in China have employees that have studied abroad and have conducted business with interbank institutions globally, so at this level, this can be leveraged to ensure a business approach that brings instituional level Chinese entities to a global audience, and vice versa” – Biyi Cheng, Head of Greater China, CMC Markets
“With regard to the government directive that is instructing the closure of a large number of regional exchanges, the operators of the exchanges will want to completely adapt their model toward connecting to the external providers. They need to learn how to run the business model through API connectivity to multi-product liquidity sources, or operate a white label business in the way that an international FX brokerage would construct its business, whilst still ensuring that it appeals to large existing customer bases and gains new ones as the new products are added” said Mr. Cheng.
In China, FinanceFeeds is aware that any form of API business is illegal, however a parralel market exists. The Chinese firms are very willing to attempt new methods of market connectivity to deeper liquidity and varied asset classes which provide OTC and exchange traded products on one platform.
As far as staying on the right side of the long arms of the Chinese government’s reach in terms of what type of connectivity is permissible and what is not, China generally very much open to new business and if companies and their overseas providers operate according to the law framework of the government then that is fine and will create an industry standard in China.
Mr. Cheng considers that overseas partners such as CMC Markets and other well recognized institutional providers need maintain a cautious approach when beginning to work with local exchanges. The way they do business traditionally is not compatible with the western style of operating electronic financial markets, therefore the framework is very different to that provided under the remit of western regulation.
One of the reasons that local exchanges have been restricted to just one per region is that in many cases, the business model of smaller regional exchanges was at odds with that of established exchanges in that many were not really exchanges and instead were b booking order flow.
Mr. Cheng considers that in those cases, “their business model was wild compared to large listed products providers in heavily regulated parts of the world with large central exchanges, and as a result of the stigma that has arisen, most providers have wanted to separate the business they are doing in China from other regions, however nowadays there is a very structured means of accommodating Chinese institutional business and making it a core business activity, as both can both mutually benefit each other, despite the big challenge on both sides.”
“Many overseas suppliers want to improve their branding in China via connectivity to local exchanges, however the local exchanges could damage the reputation of an overseas reputable provider if they are what I previously described as ones with a ‘wild’ business model that have attracted the disdain of the Chinese government” said Mr. Cheng.
“Partnering with smaller exchanges that do not conduct their business properly could also lead to action from the Chinese government if the relationship cannot be maintained well and the business model is going to be not successful the government may intervene which would likely put a stop to the opportunities of connecting to such exchanges in future” – Biyi Cheng, Head of Greater China, CMC Markets
If API business is illegal in China, how can internet blocking be avoided and how can an API connection actually work at all?
With regard to connectivity, API business is illegal in China, but only within China’s borders and the all-seeing-eye of the notorious Chinese internet firewall.
Mr. Cheng explained that as a result of the restriction on API business only applying to the Chinese mainland, API servers based outside China and connectivity to Chinese exchanges by institutional liquidity providers works well without any restrictions. This way, the government has enough control as the partner is an established, fully Chinese owned exchange with government shareholding, and all can be monitored sufficiently.
“If an exchange is connected to its client base via MetaTrader 4 as a front end trading platform, then they must use a liquidity management system and liquidity bridge such as those provided by oneZero, PrimeXM or Gold-i, which are well positioned to provide an integrated liquidity connection between the supplier (CMC Markets) and the local exchange” said Mr Cheng.
“As you say, inside China, no venues or suppliers can connect via an API, but outside is fine, therefore nobody will put API server inside China, as all the core data would be on the government server and the government will then notify them this is illegal and block the entire company from cyberspace, including their website, payment channels, email server, trading platform and access to liquidity. Effectively the entire opertions would be switched off by the government” said Mr. Cheng.
The adherence to Chinese government directives is unanimous in China. It is highly unlikely that any party would ever attempt to circumvent the framework because it will be detected immediately by the Chinese internet system, and also Chinese culture is one of tolerance and adherence, and of developing business and innovating peacefully rather than any form of rebellion whatsoever. This is one of the reasons why Chinese business is so incredibly successful.
Mr. Cheng confirmed these observations, saying “Yes indeed, Chinese culture is one of tolerance and peacefulness, and as a result the business environment is progressive and well organized, and business owners do not display animosity toward competitors.”
“In the Tier 2 cities, young and successful people are more go-getting, as there is a temptation to make money very quickly, something that many entrepreneurs in the Tier 2 towns have been very successful at, but regardless of that, they are pragmatic, sensible and work toward continual development and are usually benefiting from the government’s highly well organized framework which actually empowers them rather than hinders them, hence when you combine the cultural aspect of lack of will to rebel and the pragmatic approach, it is a winning formula” – Biyi Cheng, Head of Greater China, CMC Markets
“It has been the case for a few years now that investors in illiquid assets such as vast real estate projects where they have a long term view and gain vast revenues each month from leases but will not cash out for many years, want liquid markets for instant profit on their monthly revenues” said Mr Cheng.
“The domestic futures market and property market are struggling, therefore investors are are looking for channel of liquid and highly accessible assets, therefore this channel is absolutely suited toward Chinese exchanges partnering with overseas firms” he continued.
End of the large IB?
Mr. Cheng concured with much of the research into this matter conducted over the last few years by FinanceFeeds in that many of the entities now interested in founding new institutional companies within China that would take liquidity from Western providers and then redistribute it to local exchanges or OTC brokers in China come from other businesses and have made their wealth in vast agricultural development projects or real estate, and until recently have had little exposure to the complex institutional electronic trading world.
Despite this, many of them have quickly formed an extensive understanding and they now know everything about the institutional world so there is no need to do any teaching, thus they can take liquidity and become a prime broker and sell that to brokers in the mainland.
As a result of this new availability, IBs, many of which employ over 100 staff in each office and have massive portfolio management operations are now no longer satisfied with being an IB.
Mr. Cheng agrees that via their existing IB collaboration with overseas providers they have gained a deep understanding of the risk management systems and how execution needs to take place, and can easily do it themselves.
The interesting matter here is that most Chinese IBs are responsible for over $300 million or more in assets under management, and nowadays they want to ensure that their customers are belonging to them rather than being sent to overseas firms directly.
“You are right” said Mr. Cheng. “It is very clear that the IBs are now becoming broker-dealers and taking liquidity directly from prime brokerages which could be large property magnates that have set up an institutional firm in China to redistribute liquidity on a business-to-business basis, and in cases like this, CMC Markets will provide liquidity on a prime of prime brokerage basis directly to those prime brokerages in China. Under this system they would then redistribute the liquidity and create a new ecosystem in the prime brokerage business within China rather than sending clients and their funds abroad for execution by retail broker desks abroad.”
“When establishing this type of business with new primes in China, the all important relationship based business model is essential. We would meet face to face and tailor the institutional product to suit them. Each institution in China has a unique requirement for service so we have to fit these requirements on a one by one basis. It is not standardized like in the West, in China it varies on a per institution basis” said Mr. Cheng.
FinanceFeeds agrees with this dynamic and considers that the connectivity to exchanges to bring global liquidity to Chinese clients whilst still remaining under the supervision of the Chinese government is a very important step to take, as is the providing of liquidity directly to Chinese entities on an institutional basis.
There are many reasons for this, but one significant one, aside from the IBs no longer wanting to settle for sending their clients abroad, is that the People’s Bank of China which owns SAFE, the FX regulator, and is in turn owned by the government, is taking a swipe at OTC FX IBs sending sums of money abroad.
The FX regulator said in a statement which was issued on December 31 2016 that it wanted to close loopholes exploited for purposes such as money laundering and illegally channeling money into overseas property.
While the regulator left unchanged quotas of $50,000 of foreign currency per person a year, citizens faced extra disclosure requirements from January 1 this year.
The de facto way of doing business via IBs is to found a joint venture partnership which is partially owned by a Chinese entity which in turn has a percentage owned buy the Chinese government as is mandatory, and then for the Chinese IB to manage customer relations, portfolios, retail client accounts, withdrawals, back office functions and the general operation of the business, whilst using a Western broker as the actual dealer.
This requires sending funds to and from overseas firms, and with the facilitation by China UnionPay which is the state owned merchant services provider for credit cards and online payments, to be able to have payment agreements with Western companies, as well as various other means, it has become a bit easier these days.
However, the long arms of the Chinese Communist Party are never far away and China’s authorities have sounded the alarm in recent weeks over the risk of capital outflows from the economy, but there was little evidence at Beijing and Shanghai banks on Tuesday that Chinese individuals were rushing to lock in 2017 quotas to buy foreign exchange.
According to many reports in China, much of which are censored by the government, very few people arrived at banks in order to sell yuan for dollars on the first business day of the new year, when buyers in theory could have made use of their quotas.
Under China’s capital controls, individuals are permitted to buy up to $50,000 in foreign exchange a year, and data shows January is typically a standout month for onshore foreign currency deposits.
This is a difficult thing to consider when taking a multitude of deposits in one go from an IB in China.
The new rules stipulate that customers of firms that need to send money abroad must give reasons for doing so, including having to pledge to the government that any money sent abroad won’t be used for overseas purchases of property, securities (including online trading), life insurance or investment-type insurance. While such rules aren’t new, citizens previously didn’t have to sign such a pledge.
China, therefore, is the new land of institutional multi asset opportunity.
Main Image: Andrew with Biyi Cheng at iFX EXPO, Hong Kong 2017