This Day In History: February 17, 2012, CFH’s FX prime brokerage deal with Morgan Stanley represents halcyon days which are now just nostalgia

How times change in the prime brokerage sector. Exactly five years ago, CFH Group was the darling of major interbank PB divisions. Today, it is a small part of a gaming empire

Prime of prime relationships and the future

London. The global city. The world’s ultra-modern, well-organized and completely sustainable institutional market place.

The city in which vast corporate entities with their roots steeped in pre-industrial revolution pomp and circumstance still grace Fenchurch Street, Threadneedle Street, Cornhill and Lombard Street, the length of establishment being part of their evergreen credibility, yet their futuristic approach to business and large-scale technological advancement combines the business ethic that has been garnered over centuries with the astute and learned leadership of today.

It is quite widely recognized that such a pinnacle of the world’s financial markets economy is London, that it continues to go from strength to strength, and is not even part of England’s mainstream, but is a global and independent economy and commercial environment in its own right, the suited graciousness of its executives being an example to the world.

Thus, with 0.0009% of the entire European Union’s workforce employed in London’s financial center, yet just one square mile being responsible for an astronomical 16% of all tax receipts for the entire continent, and 49% of all Tier 1 interbank electronic trading order flow going through just six institutions nestling along the banks of the once dilapidated docklands of Canary Wharf.

Looking at anodyne, cold figures such as these is a clear and sober reminder of the reality that quite simply, London is a powerhouse and always will be. Corporate failures and large scale calamities in which brokerages, prime brokerages, liquidity companies or their respective infrastructure providers disappear are almost non-existent, whether large or small, retail or institutional.

The UK, despite its overstretched (and absolutely reckless) attitude toward unsecured lending to people who could not repay their loans which in turn caused the near collapse of many large banks and a ‘credit crunch’ that lasted for several years longer than the same situation in the United States which was rectified very quickly, has been free of scandalous demises of large institutions, with perhaps the exception of Barings over twenty years ago.

Even that did not affect the general environment of London’s trading ecosystem. So, in that case, where is CFH Group these days?

On this day, just five years ago, institutional liquidity and technology provider CFH was in its prime (excuse the pun!).

Although its roots are in Denmark, a nation which has an extremely high commercial standard in many specialist areas from luxury audio equipment to financial technology, CFH Group’s mainstay has been London for quite some time.

Eschewing the Square Mile, CFH Group’s offices are in Buckingham Palace Road, on the border of the West End and residential Pimlico, marking it out as somewhat different to its peers.

February 17, 2012 was a high point for the company’s CFH Clearing division, which on this day five years ago signed a FX prime brokerage agreement with Morgan Stanley during its program of aggressively building market share in foreign exchange prime brokerage. The arrangement with Morgan Stanley allowed London-based CFH Markets to extend interbank access to clients either through existing banking facilities.

Five years is a short time in the development cycles of many products in many industries, but not in this one.

Five years is a veritable lifetime in the electronic trading business, and since the halcyon days of CFH’s ability to sign massive prime brokerage deals with Tier 1 FX dealers with ease and aplomb are sadly a distant memory.

A period of consolidation and some key mergers and acquisitions took place subsequent to CFH Group’s deal with Morgan Stanley, and in recent years, prime brokerage divisions of banks have become extremely risk averse, with Citigroup, the world’s largest FX dealer by market share with 16% of all global FX order flow being handled by its London operations, made a public report in the summer of last year stating that it predicts a 56% default rate when extending counterparty credit to OTC derivatives companies.

Subsequently, whereas it used to be entirely possible to obtain and maintain a prime brokerage agreement with a balance sheet of between $5 and $10 million, it is now very difficult to keep on in the good books of a bank’s prime brokerage division with even between $50 and $100 million clear.

Quite clearly, risk aversion is manifesting itself in particular within the OTC prime brokerage divisions of banks, and whilst most of London’s non-bank liquidity providers, prime of primes and ECN participants have balance sheets that would even make the Sultan of Brunei sit up and pay attention, there are those which clearly do not.

In February last year, FinanceFeeds became privy to information which indicated that CFH Group was in discussions with a potential purchaser, which was a large company with public listing on the London Stock Exchange, denying it when approached by FinanceFeeds.

Our information at the time stated that there was a proposed acquisition in place, and final approval by the Financial Conduct Authority was pending, which proved indeed to be correct information.

Speaking to CFH Group CEO Christian Frahm at the time, FinanceFeeds discussed the continuing consolidation that has been occurring over the past few years.

Mr. Frahm explained “We came out after the Swiss National Bank’s removal of the 1.20 peg on the EURCHF pair, and said at the time that this sector will consolidate. We brought onboard Dipak Rastogi who is one of the top people in the world on the mergers and acquisitions side, and have worked ever since to put in place an industry consolidation play.”

“This is what we are now executing, the acquisition of smaller players to put them under our umbrella” – Christian Frahm, Founder & CEO, CFH Group.

Just a year ago, CFH Group enlisted Dipak Rastogi, CEO of Citi Venture Capital International as a non-executive director, alluding to private equity aspirations.

Whether these moves were made to deflect industry sentiment that CFH Group was at the advanced stages of negotiation with an acquiring firm or not is anyone’s guess, however later in the year, cracks appeared to show as it had been suggested that relationships with prime brokerage divisions of banks had become difficult to sustain.

In August last year, charismatic and knowledgeable prime brokerage expert Nick Mortimer left his position at CFH Group where he was responsible for maintaining relationships with institutional desks at banks, and headed into the retail FX industry by joining MahiFX as Head of Retail Sales.

Mr. Mortimer is a regular commentator on all aspects with regard to prime brokerage and the currently very hot topic of how prime of prime solutions providers and liquidity aggregators interact with banks that are increasingly unwilling to give credit to OTC derivatives firms.

Mr Mortimer joine the CFH Markets division of CFH Group in July 2011 from Marex Spectron, where he was Senior Business Development Manager.

For two years, Mr. Mortimer was based in Geneva at ACM (now Swissquote) where he was Head of Liquidity Management. In 2005, Mr. Mortimer joined ABN AMRO in FX Prime Brokerage Sales, a position that he held for 3 years, thus his institutional level pedigree is indisputable.

It was on November 14 last year that the final outcome of CFH Group’s fate was sealed.

FinanceFeeds had exclusively gained considerable information and conducted research which concluded that the company was about to be bought by Playtech and had been ready to announce the deal via the London Stock Exchange’s reporting system later on that morning.

A late night telephone conversation between FinanceFeeds and CFH’s senior management in order to gain full commentary on the matter resulted in further deflections, however our research was correct and accurate, hence we broke the news in the early hours of the morning on November 14.

In the UK, the reporting rules of transactions between publicly listed companies and those being acquired are somewhat different to those elsewhere. Under British law, the outlined terms of the overall deal are required to be published, and not the actual amount that finally was transacted.

It was officially reported that CFH Group had been sold to Playtech for $120 million, however it is highly unlikely that this will ever be achieved.

Our analysis 

Just a few hours later, following dialogue through the night between the two parties, the deal was sealed and the terms were made clear.

On the morning of November 15, Playtech confirmed that it is set to acquire 70% of CFH upon completion of the acquisition, which is due to take place on 30 November 2016. The remaining 30% will be subject to put and call options between Playtech and CFH’s management team, who are remaining with the business, and which can be exercised in 2019.

Let’s take a look at what the figures are, and why they should be viewed with caution

A figure of $120 million has been considered as a ballpark for the acquisition, however such a figure should not be taken as a given, as the details of how the deal is structured are far more important to consider.

Upon concluding the acquistion which is due to take place at the end of this mont, an initial consideration of $43.4 million was agreed, on a cash free and debt free basis, for 70% of CFH’s fully diluted share capital, representing a multiple of approximately 7 times the current EBITDA run rate.

In addition, consideration for the remaining 30% of CFH Group has been set forth, which will be subject to a put and call option which is exercisable in 2019 at a multiple of 6.0 times CFH’s adjusted EBITDA for the year ending 31 December 2018, capped at $120 million less the initial consideration $76.6 million for the 30%.

This means that it is entirely possible that the firm will not be acquired for $120 million.

As the non-bank FX industry continues to go through a consolidation period, many deals of this nature have been structured in this manner previously, a notable example being GAIN Capital’s acquistion of British CFD and Spread Betting company City Index, which was completed in April 2015, the actual transaction between City Index and GAIN Capital at the time of bid in October 2014 was reported to be $118 million, however subsequently, it emerged that the net purchase price was actually $82 million, which included $36 million in cash.

It was never reported in any publicly available document, either with the New York Stock Exchange upon which GAIN Capital is listed, nor with the Financial Conduct Authority (FCA)’s regulatory reporting system (RNS) as the only aspects of any merger or acquisition that are publicly reportable in general terms are the original terms of the proposal. What ensues during the transaction period or afterwards is not subject to reporting.

Examining the value that an acquisition of a company which has a liquidity distribution relationship with major Tier 1 banks and electronic communication networks, a technology division, and some peripheral entities including two platform providers and an educational resource, what is the mainstay?

In terms of prime of prime credibility, CFH Group is by no means to be overlooked, as it is a longstanding part of the landscape of the institutional liquidity provision sector with retail brokers as its clients, however its complexity, technological prowess, and ability to operate as a fully integrated prime of prime is very much in the shadow of that of compatriot Saxo Bank.

NetDania is a very cleverly designed system, and has a very attractive per-seat licensing option which means that the NetStation platform is very much geared toward professional traders with high volumes, thus allowing brokerages to profit highly from the fixed fee licensing and large volumes rather than paying MetaQuotes, quintessentially a retail platform, a volume based fee, however MetaQuotes dominates to the point that NetStation cannot even get a look in, and professional traders tend to opt for either the proprietary trading platforms of North America’s exchange listed sector, or customized algo-based solutions from Spotware Systems.

Whilst on the subject of platforms, Tradable has was moribund for several months and has now vanished from the picture entirely.

FinanceFeeds analyzed the situation carefully, deducing that it has been nigh on impossible for many new firms with API-based platforms to gain any traction over the traditional MetaTrader 4 platform which was initially designed to operate in a closed ‘warehouse’ environment and not to connect to external liquidity feeds from prime brokerages, and has had to be adapted by specialist liquidity management technology and bridge providers in order to operate in today’s retail trading environment.

That in itself was a very significant indicator that MetaTrader 4’s dominance would be set in concrete. When the retail trading firms that do not develop their own platforms switched en masse away from the warehouse model at the beginning of this decade and the entire trading topography began to emulate the institutional world, instead of eschewing MetaTrader and opting for all new, a-book orientated FIX API-connected platforms with novel applications and an opensource developers area for the purpose of designing new trading tools, the vast majority of brokerages remained steadfast in their loyalty to MetaTrader 4 and a whole host of specialist developers began adapting its interface in order to connect it to live liquidity streams.

The Tradable platform appeared on the scene just over four years ago, a bastion of leading edge modernity, oozing ‘new generation’ right the way from the composed classiness of CEO Jannick Malling himself right the way through to the execution of the platform’s design. The world’s very first application-based platform, within which users could develop their very own trading applications, and the ability to avoid needing any liquidity bridge, as it connected directly into a broker’s infrastructure and a liquidity provider’s price feed via API, revolutionary in the retail trading platform business at the time.

What has become patently apparent over recent months is that Tradable has begun to disappear entirely. Slow takeup and the unfaltering dominance of MetaTrader 4 is one major factor that a developer of any new platform must consider. In the Far East, a massively important region for retail trading, Expert Advisers (EA), which are automatic trading robots are very popular, and MetaTrader 4’s compatibility with the several thousand EAs that are currently available is one reason for its initial rise to absolute dominance.

With such a stranglehold over the entire market, those attempting to reinvent the wheel must do so by not spending a fortune, and by knowing their niche, as well as respecting the massive shadow that the one all-encompassing company – MetaQuotes – casts over everyone else.

This was Tradable’s achilles heel.

Instead of going the route of Spotware Systems with its cTrader and cAlgo solutions, in which Spotware anchored its development by gaining a very large customer – FxPro – in order to be able to have a steady core income whilst evolving products as well as being able to provide customized platforms for brokers that commission the firm to build one for them instead of going to the extent of investing in a proprietary platform, Tradable held itself out as a firm with ambitious new ideologies and attempted bold steps into uncharted waters.

Japan is a very important case in point.

Just two and a half years ago, Tradable had been taken up by a handful of brokers and was still in start-up mode. India-focused, UK-based Tradenext was one of the very first firms to adopt the platform, however the volume conducted on Tradable was negligible and Tradenext continued to major on MetaTrader 4, even though Tradable was in its ‘Tesla moment’ of revolutionary wow factor appeal at the time.

This should perhaps have been a measure to bear in mind and take into account for the firm, but it wasn’t. Tradenext went West, and takeup among other brokers was relatively tardy.

Instead of regrouping and looking toward securing a core client in a familiar market, Tradable looked toward entering Japan, a notoriously impenetrable region with an equally impenetrable allegiance to domestic market companies. Tradable held hackathons in Tokyo, where young developers could produce their own trading applications against each other.

CFH Group spent a massive amount of resources wooing large Japanese companies to take Tradable on board, which is a painstaking and very expensive task that usually amounts to corporate loyalty to Japanese firms an a hostility toward those from overseas.

A costly process for Tradable, however MONEX Group did indeed take the platform onboard, Japan’s uniqueness in the Far East in its aversion to MetaTrader 4 and lack of use of automated robots and EAs being an advantageous point, but still the Tokyo-centric nature of the country’s trading environment and its hierarchical business structure is always too much for Western firms to manage.

MONEX has since discontinued the Tradable platform.

As far as this can possibly be researched, we estimate that Tradable’s entire expenditure thus far to be approximately $10 million, however the lack of market traction and recent retraction and corporate silence generally speaks volumes.

Consequently, it has been suggested by internal industry sources that Tradable is not part of the acquisition by Playtech, and even if it did, it would yet again fall foul of competition which yet again would be Saxo Bank, with its own SaxoTraderGo platform which has an OpenAPI that allows developers to customize it to their needs and integrate it into their own user interface as an integral component, thus marking it one step ahead of Tradable’ app based nature.

So, bearing all of this in mind, what is the value here? The value is the client book of retail brokerages which is highly prized in a crowded industry in which many new prime brokerages and liquidity providers now exist, and equally of importance is CFH Group’s relationship with the banks.

This, when all is said and done, is the entire value.

Thus, when the acquisition takes place and the initial $43.3 million has been paid, and Tradable is jetisoned, probably followed by a disbanding of Tradimo which could well be absorbed into Playtech’s gaming software enterprise for their technology – remember that Tradimo was designed, established and privately financed by poker software firm before CFH Group acquired a 50% stake in it thus it may be returned to its gaming roots, there is a long period of time to go before the remainder of payments are due, and some of it is speculatory as it relies on a put and call option which does not mature until 2019.

The question therefore remains, is the liquidity relationship with banks and the prime brokerage section worth $120 million to a gaming software company, and will institutional firms want a gaming company to own their liquidity partner, and did CFH Group sell to Playtech even to raise just over $40 million as a last ditch measure to add capital to its balance sheet to retain its final PB relationship?



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