How much do clients deposit over their entire lifetime and what are the associated costs? – FinanceFeeds research
FinanceFeeds examines the differences between OTC derivatives trading activity and costs to brokers on a global scale. Lifetime value, the changes that need to be made to cost model, possibility of external fees and how the futures sector can lead the way are disseminated.
great deal of investment of R&D resources and marketing budget is plowed into bringing onboard new customers, an increasingly difficult task in light of two major factors that have emerged over the last three to five years.
The first being the level of understanding among retail clients which has led to fiscal cautiousness and at the same time demand for a sophisticated trading environment.
The second being the massive competition which comprises several hundred retail FX companies offering similar services.
The similarity of platform used by most brokers (MetaTrader 4) means ease of transfer of clients from one brokerage to another, however this also means that clients can leave easily, negating the cost of acquisition.
In the United States, in 2011, the average retail FX account size was $3,800. However the cost of acquiring a client at that time was approximately $500, including all components required to acquire clients – remuneration of sales team, marketing tools, digital media buying, and advertisement campaigns as well as the cost of
paying commission or a revenue share to partners and running advertising campaigns.
Interestingly, according to research by Citigroup, the average retail FX account size across the world’s 4 million retail FX traders in 2015 was $6,600.
Today, it can be taken on reasonably good authority that retail clients who have made a recent entry into the FX world will deposit an average of $6400 in their entire lifetime, representing the average $3,800 and then a further few deposits taking it to $6400, with an average lifetime of six months, for all clients outside North America.
In North America, client lifetime is two years, with a total average deposit during the client lifetime of $15,200, including their average initial deposit of $6,600, a figure which has not changed over the past two years.
The different dynamic with regard to client lifetime values and trading capital is the listed derivatives market centered around Chicago’s electronic futures exchanges and the respective professional trading platforms that connect to them.
Many platform providers that onboard clients which trade on CME, ICE or other Chicago-based exchanges stipulate a minimum deposit of $50,000 and client lifetime is often over ten years, with traders of this type having various portfolios with various futures brokers, often depositing several million dollars during the course of their custom.
The lack of leverage in futures trading has been an instrumental factor toward educating the serious and steady traders that execute on exchange that large capital is required over a long period of time. As a result, ‘churn and burn’ is virtually non-existent, and is a dynamic that is heavily frowned upon by US regulators and exchange operators alike.
Perhaps this should be used as a model for the development of the OTC retail markets.
Account size has actually risen – but there are hidden costs
This may have increased the average account size, but the cost of entering and maintaining potentially fruitful emerging markets such as mainland China is very high, largely because the high-touch approach is required.
Necessitating many visits to China by executives to maintain relationships, and a constant rapport-building exercise between partners departments of brokerages and introducers who now understand that their contribution is so instrumental to the revenues of a retail broker that they are demanding very high remuneration packages.
Gone are the days in which introducing brokers and affiliates were small one-man businesses. Nowadays, many introducing brokers, especially in China, are pretty much brokerages in their own right with 100 staff, their operations emulating that of a retail broker.
The only difference being that the dealing is being done by a brokerage with which they place business. Whilst a model like this removes the need for a large direct sales team for many brokers who can concentrate on execution and maintaining margin balances in an omnibus account from which the introducing broker can then handle every aspect of client facing activity, an important metric that is often omitted from the ‘cost of acquisition’ estimates is that it costs the introducing broker greatly to operate, and rebates and revenue share from a brokerage is what pays for this.
Therefore, it is vital to consider not just the traditional (if you can call pre-2011 traditional!) aspects when counting the cost of acquisition and retention, and adding those components up. Instead, it is worth considering the single payment made per month to each introducing broker and the likelihood is that this figure is not dissimilar to the multiple components that make up onboarding direct clients.
Mark up revenue
One of the styles of revenue is a mark up on the client account. This means that the IB agrees with CFD/FX firm to mark to the client account by a agreed amount say 1 or 2 full pips.
So if the market on the Dow is 25520-25521 the the mark up will show 25520-25523 ( 2 pip mark up ).
Example client opens $10 per point on the Dow. Normal spread paid = 25520-25521= $10 per point so $10 paid in spread
Mark up: 25520-25523 = 3 pip spread, and the client pays $10 per point pays $30 spread
Of the above $20 goes to the IB and $10 to the retail FX firm, hence my stipulation that those extra pips go to the IB.
Will the clients entertain that their accounts are marked up in order to pay the mark up to the IB. Not on MiFiD. This will cause a significant drop in revenue for the IB.
Spreads tight as they are will become tighter. In the real world it’s the false spread on the B- Book operators actually causes the client to lose. If the client is marked up the the chance of the Client losing is even greater.
There will likely be no more trail commissions for IBs on any client unless the IB can demonstrate interaction and active client management to the CFD/ Spread betting or FX firm. What the IB will get is an introducer commission of a one off or maybe 3 month payment, or if the FCA decides to extend its ruling about paying for additional asset management services to cover how clients are introduced and how the introducers are paid, then external consultancy fees may arise.
This means that the IB revenue model in 2018 post MiFiD II is over. The revenue will fall for the IB and will cause an exit for the CFD firms if IBs as the payments will not justify the effort or motivate the IBs.
What can the retail FX firms do?
There is no way that the large companies which form the mainstay of this industry and have striven to develop a vast and loyal network of large scale IBs in China will allow this to happen, as it is too big a revenue driver.
One of the things that could be done is to simply put all IBs into a salary, bonus package that make them all employees or sub-contractors, as was the case in the IT world in the 1990s. I can remember the introduction of the Inland Revenue directive IR35 in the United Kingdom, which directed that all self-employed contractors or companies based on site that are reporting to internal project managers were taxed in exactly the same manner as employees, decimating the IT contracting market very quickly in the United Kingdom (I remember many colleagues giving up their business and getting permanent jobs in bank R&D departments in the late 1990s/early 2000s – Ed).
The other option is to devise a compliant action plan, that demonstrates the IB has had active input with the said client.