FXCM: Over and out, leave the keys on the table. Op Ed

We analyze the entire situation that FXCM and its directors and shareholders now find themselves in, and why it looks like there is no way back from the brink as one of America’s largest and most highly respected electronic trading firms goes down the pan


Just when, after the litany of mergers, acquisitions and corporate restructures that have punctuated the entire retail electronic trading industry over the past two years, it appears no longer possible to be surprised by anything, a giant bombshell is dropped.

The question that is likely to be on the mind of every single FX industry executive from prime brokerages, to Tier 1 banks, to introducing brokers, to shareholders, to regulatory authority figures is – what will be the ultimate fate of FXCM?

invast pureprimeOne has to extend absolute respect to the Commodity Futures Trading Commission (CFTC). Very few other regulatory authorities would be capable of conducting such a detailed investigation and unearthing quite such a remarkable trail of very cleverly masked deception, leading to the banning of one of the world’s largest and longest established FX brokerages from its own domestic market.

Until yesterday, the focus was on how FXCM had navigated its exposure to negative customer balances during January 15, 2015, when the Swiss National Bank removed the 1.20 peg on the EURCHF pair and the company’s series of shrewd endeavors in order to maintain an even keel, keep the company in the same condition as it was prior to the notorious ‘black swan’ event.

FinanceFeeds met with CEO Drew Niv last year at FXCM’s head office in New York, where he demonstrated how he had handled the situation with remarkable calmness and poise considering that the company had a matter of moments to come up with a solution to its black hole, and a deal with Leucadia had been brokered on a hand shake. There was no time for due diligence, auditors, management consultants or underwriters. It was now or never.

During that period, and a very long time before, FXCM had all the while been maintaining that it operates a no dealing desk platform, having made several public statements that its dealing platform was completely operated on an agency basis – that being the transfer of all orders directly to the liquidity provider and no trades are internalized by a dealing desk, a parlance that was even more believable when the Swiss National Bank’s unexpected action was taken and ‘A-book’ brokerages were affected whilst ‘B-book’ brokerages were able to mitigate exposure as they were not transferring trades to a live market.

It transpires, however, that FXCM had been intentionally trading against its customers via a complex and clever internal structure, whilst all the while making statements that it was operating an A-book execution model.

What now for FXCM?

Being banned and removed from its own domestic market in the United States will have severe enough consequences for FXCM.

The majority of its direct retail customer base is in the United States, and other Western nations which, although conducting their business via offices in Europe, Britain and Australia, will likely view the mainstay of the firm’s US office as its commercial figurehead, thus will call into question how their execution has been conducted over the past eight years.

As far as commercial damage is concerned, this is, in our opinion, a potentially terminal situation for FXCM and any recovery will be highly unlikely.

Before even considering lack of customer confidence in that they have effectively been fed complete untruths by a company that instigated an internal set of algorithms to intentionally trade against customers whilst all the while maintaining quite the opposite in the eyes of the regulators and customers, there are two sets of shareholders to consider.

Will the shareholders sue FXCM?

One set of shareholders have demonstrated patience over the last two years, largely out of necessity, and partly out of belief in CEO Drew Niv, who was widely regarded as one of the most astute and competent CEOs in this entire industry.

This set of shareholders are the shareholders of FXCM itself, a publicly listed company which has had the finger pointed at it by the New York Stock Exchange for maintaining a share price lower than $1 for a six month period after the Swiss National Bank event, $1 being the minimum share value to maintain listing on the New York Stock Exchange.

Shareholders had witnessed their stock diminish in price from $17 prior to January 2015 to just a few cents thereafter, however FXCM’s reverse stock split revitalized the prices and shareholders did not rush away in droves. FXCM eventually delisted from the NYSE and is now listed on NASDAQ, a very rare venue for stock of electronic trading companies, alluding to confidence even by NASDAQ that the company would be credible enough for its strict listing criteria.

They may now wish they had rushed away in droves.

Today, FXCM’s share price is collapsing, and with its US customer base ready to be completely migrated to GAIN Capital, its New York office no longer allowed to onboard new clients, and its CEO Drew Niv and senior Managing Director William Adhout both banned for life from being CFTC members, the situation is far more grave than that of the $300 million exposure to negative balances in January 2015, in that this time it is ultimate, and has been brought about by corporate falsehoods.

Bearing this in mind, shareholders may commence litigation against FXCM for creating a situation in which they could lose their entire investment.

The second set of shareholders are those of Leucadia which is a giant North American holdings company that, through various subsidiaries, engages in telecommunications, healthcare, banking, investment services including Jefferies, which is 28% owned by Leucadia.

Leucadia has a market capitalization of over $10 billion and is known as a smaller version of Berkshire Hathaway and its shareholders and directors are absolutely nobody’s fool.

The backlash from any potential action taken by Leucadia shareholders against Leucadia for granting a $300 million emergency funding deal to FXCM without doing any due diligence, on a handshake, trusting that the structure of FXCM and its senior management team were transparent and bona fide, could be far worse than any court room tantrums from speculative FXCM shareholders.

Whilst FXCM has paid down a large proportion of the loan, Leucadia has recently taken an ownership position in FXCM, In September 2016, Leucadia took a 49.9% interest in FXCM’s operating companies, with FXCM retaining the remainder. Should this be the end of FXCM, the cost to Leucadia will be far higher than its initial interest in the firm, which will not be palatable to shareholders, who could hold the company accountable for making a reckless decision to lend $300 million in the first place, which paved the way for an interest to be taken in a firm which is now facing its nadir.

Current view from within – Will they stay or will they go?

FinanceFeeds this morning spoke to a source on the inside who is party to a huge amount of information, who explained “This is pretty tough indeed – they are resilient though. We have just got to see how customers take it, if they stay or not with FXCM”

“We also need to see if there is a follow up from the FCA and other regulators globally as a result” (last time FCA followed on CFTC/NFA decisions regarding limit orders slippage – Ed.)

“In the end they are losing 20% of their revenues or so I believe but paying $50 million out of the Leucedia deal thanks to freed up capital so net net effect on firm financials is not going to be massive. I feel bad from FXCM USA employees though as there is probably going to be a bloodbath there if they relocate the firm to Europe or UK.”

“In the end, this might be good for the firm though as they kept a lot of mediocre US based employees for loyalty reasons and this is the occasion for them to cut the fat and restart fresh in Europe by only hiring required staff & moving some activities to low cost centers like Israel or Bulgaria” said our commentator.

Introducing brokers up all night counting losses

FinanceFeeds has, during the course of the night, spoken to several prominent FXCM introducing brokers across the world, many of whom will have their business affected by the closing down of FXCM’s US entity.

One particular introducing broker explained to FinanceFeeds “I am still working through the night. This is going to cost me some money. I have been in touch with GAIN Capital and currently we will have to see what the introducing broker deal will be on existing clients once the FXCM client book has been taken over by GAIN Capital.”

There will be a significant fall out from introducing brokers in China. FXCM is a dominant force among introducing brokers in China, and there is now absolutely no way that this can continue. Chinese introducing brokers who send business to Western firms are often portfolio managers and are reliant on solid and transparent trading principles from the brokers that they send client orders to for execution.

If a portfolio manager with over $250 million in assets under management – quite a common figure in China – displays any activity that could damage trust, clients of the portfolio manager will take this up with their portfolio manager that a company that they are sending investors funds to is trading against them, which means that any portfolio manager who realizes this will pull their business away as they would face losing the trust of their customers otherwise.

FinanceFeeds believes that no surprises will be in store for introducing brokers whose customers are now being taken on by GAIN Capital, largely because at this time during which one of the largest firms in this industry in one of the most highly respected regions has been called into question, there will be no way anyone will want to rock the boat. FinanceFeeds has reached out to GAIN Capital CEO Glenn Stevens and will report on this matter when relevant.

FastMatch – Will it have to break away to maintain transparency?

Single dealer platforms rely on complete dealer transparency, and FastMatch, launched in 2012 in partnership with FXCM and Credit Suisse is an electronic communication network (ECN) which offers large pools of diversified liquidity with complete impartiality.

Now that it has become known that FXCM, which owns 32% of FastMatch, has been deliberately employing high frequency algorithmic systems to intentionally trade against its customers, doubts could be cast over whether FastMatch should be associated with such an entity.

It would not be at all surprising if FastMatch seeks to remove FXCM from its commercial structure, as what has now transpired at FXCM is completely unaligned with FastMatch’s ethos.

Recently, FinanceFeeds spoke to Dmitri Galinov, CEO of FastMatch in New York, in order to discuss the new methodology which has been developed by the company that could well be the antidote to exactly this problem.

In terms of corporate perspective, Mr. Galinov explained to FinanceFeeds “We would like to see the world without last look execution, because we feel that it would be more fair that way, however we do understand that the FX market is the biggest market in the world and the market has been operating with last look for all these years so it is not like one particular bank or broker is doing it and nobody else is doing it.”

“As far as we are concerned” continued Mr. Galinov, “when you think about what last look actually is, it is a type of free option. For example, if a customer comes and says that he wants to trade with your price, and you as a market maker say that you don’t want that trade anymore, this creates a free option for the market maker as to whether to transact or not.”

“One of the routes that we are taking is to offer brokerage-free trading to participants that do not use last look execution. The rationale behind this is to compensate a company financially if they dont use that option. The ‘free option’ of being able to use last look has monetary value, therefore we would like to offer free brokerage to those who don’t use last last look” explained Mr. Galinov.

“The second thing we set in place with regard to this was to introduce a new order type, which is called Leak/Sweep Protection, or LSP for short. “What this order type does is outsource the entire last look facility of a trade to FastMatch. Fastmatch performs the check to see whether the trade is going to go through or not. It is for clients that are using that order type, they don’t disclose the order type to the market maker which ensures that it cannot be rejected” said Mr. Galinov.

“The reason market makers use last look and those who take liquidity don’t like last look, is that this practice gives information to the market maker, and then it is not getting traded. We solved that. When the clients tried to trade, we get an order from the client but we don’t forward the order right away from the client to the market maker.

Instead, the order is held for approximately 100ms within the FastMatch system in order to see if the market is at same level and not going against the market maker and then we trnasfer it to the market maker, however if it goes agaisnt the market maker we then don’t send it to the market maker because they would reject the order. This way, relationships are better because the market maker does not know about that trade at all, we reject it to the liquidity taker instead.” – Dmitri Galinov, CEO, FastMatch

Essentially Mr. Galinov is echoing exactly what FXCM has been secretly going against, therefore it could be that an exit may ensue in the coming months.

Chicago based electronic derivatives exchange giant ICE tried to buy FastMatch in July 2015, having prepared itself to buy FastMatch from its three shareholders, Credit Suisse, BNY Mellon and FXCM, for around $200 million to 250 million. If I was a senior executive at FastMatch, I would seriously begin revisiting that offer, which not only would quell the concerns of users, but would also put FastMatch in alignment with the exchange-listed derivatives sector which is currently applying so much pressure on the OTC world.

Rebates on EFFEX liquidity deal – Where did they go?

External liquidity provider EFFEX Capital was presented by FXCM as being an independent counterparty but it has become clear that FXCM had been supporting the liquidity provider, and the firm had been paying rebates to FXCM of up to 70% of Effex Capital’s profit.

In 2013, the National Futures Association (NFA) began investigating EFFEX Capital, coinciding with the time at which Business Development Director Solvej Rendtorff joined the firm from CFH Group. At that time, the NFA inspection was interrupted by apparent misleading information provided by FXCM CEO Drew Niv and other employees at FXCM.

There is no information yet as to where these rebates were collected, however if it transpires that these went to an entity outside of FXCM, that would be a very serious felony and could carry criminal prosecution. FinanceFeeds will continue to investigate this and will report on any Securities and Exchange Commission filings that indicate the nature of these transactions.

We spoke to an institutional FX expert in New York today, who had some definitive views on this. “While EFFEX had an unfair advantage versus other liquidity providers by knowing where other providers were pricing, CFTC and NFA could not nail FXCM for much on the effect of this setup on clients and this is why the fine is so small” said this particular source.

“In the end maybe some other liquidity providers did not get the flow because of EFFEX but EFFEX got the trades by showing the best price to clients.”

We spoke to a further source in New York who explained with regard to the liquidity deal “Clients got a better service out of it in the end. It was still the best price winning the trade. Did EFFEX reject some trades when it was in their favour or fill trades going against market movements, of course they did.”

In London, FinanceFeeds spoke to a management consultancy this morning which has experience in advising on corporate policy with regard to Tier 1 liquidity provision within banks. A senior partner at the firm explained “I do not see how this is any different from any bank liquidity provision practices in this business. You always reject trades off market against the maker and fill the one against the client. Fair or not, it is not for me to judge but this is how FX has always functioned. If people want to change the rules, ok let’s do it going forward but why any authorities would fine people for accepted market practices is beyond me”.

A senior industry figure in North America this morning explained to FinanceFeeds “In the end it is just the CFTC & NFA witch hunt against the industry in my view. GAIN & Oanda are last standing but the CME will win in the end and those guys will have to be an exchange soon or send the business to the CME. Never underestimate the power of the Chicago derivatives industry!”

This situation is worse than IBFX’s internalization debacle

The consequences of FXCM’s activities with regard to misleading its entire client base with regard to how execution of trades has been conducted are potentially far more grave than other examples of execution transgressions in the past.

Looking at IBFX’s contretemps with the NFA in 2013, in which it received a $600,000 fine, the circumstances were on the face of it similar, but with much less offensive consequences.

IBFX has also been banned from the US, An examination by the NFA ensued, which initially focused on IBFX’s activities for the two-year period of 2010 and 2011, relating to price movements which occur between the time at which an order is placed by a customer and executed by the company.

As a result of this particular investigation, inadequacies in recordkeeping were discovered and the NFA was unable to fully evaluate the company’s trade execution practices.

According to the material detailed in the NFA’s complaint, IBFX used two models to execute its retail FX transactions. One was STP, and the other being a practice known as warehousing.

According to the NFA report at the time, and the parlance of the legal document on which the NFA’s complaint was registered, warehousing occured whereby IBFX acted as the counterparty for trades whose value was less than the notional volume threshold level lnterbank had established for STP trades. Interbank would aggregate the “warehoused” trades for risk management purposes and earn revenue from the bid/ask spread and from beneficial market moves that the aggregated “warehoused” trades experienced.

For the vast majority of trades, IBFX would warehouse the trades, and for the remainder of trades, IBFX used the STP model, which accounted for a very small percentage of the firm’s trading volume and applied when the contract size was at or over the specific notional volume threshold set by the firm for its warehouse trades.

Under the STP model, after a customer clicked on the bid or offer price, which included lnterbank’s predefined markup, IBFX would fill the customer’s order but only after the firm had filled the offsetting position (contra-fill) with a liquidity provider.

The NFA attempted to analyze IBFX’s execution data on all STP transactions from January 2010 up to the time the firm was acquired in late 2011. However, while the firm ultimately was able to provide historical markup information since June 2010, the NFA was unable to complete its analysis because historical markup data prior to June 2010 was not available, and for certain types of STP transactions (split fill transactions) since June 2010, Interbank’s record of historical markup changes could not be reconciled to specific trades.

As a result, NFA was unable to analyze all of the firm’s STP transactions. We understand that IBFX was selling off smaller trades to an external market maker, however it did not ever make any statement that all of its trading was A-book, and then go against the customer’s positions.

That’s it, curtains ahead

Bearing in mind that this execution model has a global presence and that customers and introducing brokers will likely never trust FXCM ever again, there is a distinct likelihood that the firm will not recover from this.

For the prime brokerages that provide price feeds and liquidity, the risk managers are probably now engaged in curtailing any OTC counterparty credit agreement to FXCM in case the company folds and cannot meet its counterparty credit commitments – especially in these days when Tier 1 banks will not extend counterparty credit to even the most stringently run and well capitalized firms. This would be a clipping of the wings from the institutional side, and it is likely that customers will flock away in their droves.

It is unlikely that any retail traders will be able to successfully sue FXCM, because actual damage to their trading accounts as a result of market making or trading against customers would be extremely hard to prove, but certainly the authorities could continue to probe and continue to find reasons to go after the company and its executives for violating laws.

Even if no customer actually attempts litigation procedure, the reputational damage is enough to create a divestment on a global scale, hence when all of these factors are borne in mind, it looks like curtains ahead for one of the world’s largest and long-established brokerages.

Anyone want to open a retail FX brokerage in America? ……

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