“Mind The Gap!” – The life and times of a man on the move Episode 52
“Who is going to provide platforms for retail traders” I am asked. How to get it right with IBs, Don’t leave Australia for the islands, and a pleasant surprise in the air
In this weekly series, I look back on what stood out, what was bemusing, amusing and interesting during my weekly travels, interesting findings within the FX industry and interaction with an ever-shrinking big wide world. This is purely observational and for your enjoyment.
Monday: “Who is going to provide these platforms for retail traders?”
As I landed at OR Tambo International Airport in Johannesburg, South Africa, and began my drive toward the magnificent suburb of Bryanston which is always my temporary home during all visits to the Rainbow Nation, and is in my opinion, along with its adjoining Sandton urban areas one of the very best neighborhoods of any city anywhere in the world, I was entertained by a call from a very good friend of mine just as I headed onto the Albertina Sisulu Highway to begin my week ahead.
Demonstrating clearly that the dialog that I had engaged in last week with a very senior FX industry professional who had attended our FinanceFeeds London Thought Leadership Conference in May had struck a chord, the direction of this particular telephone call had come about as my friend had noted the points made half the way around the world last week.
What stood out to my friend was the assertion that it’s clear that the concept of self-directed trading or investing as we know it today in pursuit of financial alpha is on the cusp of dramatic change”
“next generation”, “artificial intelligence”, “quantum computing”, “understanding investor psychology” and so on.
He referred to the takeaway from the FinanceFeeds London Thought Leadership Conference in which it was mentioned “In summary, take these aspects, blend them together, build some clever tools and then get traders or investors to subscribe in order to make their strategies smarter and more successful. All good on the surface, but traders are still paying a premium in the form of subscription-based access to the magic black box and will remain as an inefficiency in the process.”
“That combination of extra costs and an extra step in the chain means that their alpha in terms of financial return alone will by definition always be lower than that of the optimal trading machine or robot. There seems to be some parallel with the evolution of the managed funds industry here – once efficiencies are realized, the advantages can no longer be realized”
“What an interesting dialogue” said my friend during our conversation. “To make a point that we have come to the point that active trading is passive if chasing alpha.”
“If I may indulge in a response, I certainly will but my point will be that the actors wont change, just their attire” he said.
“Not sure I agree on the idea that retail traders should sit back and think of England when trading – as I do think that there will be platforms that will allow alpha returns but to a limited number of traders, given the trade IP will be out in the open, not hidden. So the edge will dissipate through time, as stated succinctly by your post – whether that be into ML or AI programs, or unstructured data. An observation is, will the mainstream brokers allow these ‘machines’ onto their platforms and into their retail client base [assume institutions are, can and have been pursuing these programs for some time ] as you still need these conduits to execute the trades” he said.
“So this is for me, a more interesting development as to the fate of the institutions that create ‘tools for brokers’ in this current environment – given that brokers now, to survive, need to cut costs and in a sense think about client profitability = (even if to simply reduce marketing and on-boarding costs) – but what can they do about it – their mindsets seem to be stuck in their retail client ‘journey’ and not the arrival, in that if there was a solution then they would have already provided it” is the opinion from my longstanding friend in the Southern Hemisphere.
“So who is going to provide these new trading platforms for the majority of retail traders?” he asked.
“I think IBs trading on behalf of their clients will have more interest in experimenting with new trading concepts such as AI or unstructured data, and certainly multi-assets, but are they not tied to the broker platforms and so its a kinda dead end argument as we know, the brokers ‘own’ the client and evolution is all style, no substance as a next generation platform . On an MT4 platform it is a misnomer”
“Is Japan and what has happened their over the past 4 years the shining light?” he asked. In answer to that, we concluded that it perhaps has been but assume that the Japanese retail suffer the same fate as their Western kinfolk, but a slower fade to grey [as the same win:loss ratio applies to retail traders in non leverage instruments], therefore so more a broker praying to their gods of volatility, hoping this is the future for retail to engage trading in a low leverage environment – but what other options does retail have?
My friend said “At the moment my observations suggest the behavioral aspects to trading are at best, at the margins – but these platforms [Quantopian and PsyQuation to name 2] that profile clients in order to allocate capital to trade even show that the great majority of retail traders are duds [very low success rate of traders migrating to capital is less than 5% ] = will this metric ever change for retail even in the age of machines.”
“Therefore the majority of retail remain in the playing field for brokers to fish, and I think over the coming years, as technology develops [trading platforms, mobile apps, new methodologies in machine trained programs to trade, there should be an exponential growth in the numbers of new traders [such countries as Africa, India, middle east come onto the bandwagon => the new fishing grounds, so the show must go on. I also suggest the ‘extreme’ marketing techniques will still be a powerful lure for retail to catch the bait” he said.
“So, my ‘opinion’ suggests, we will see new platforms develop to cater the retail trading but the retail trader will only succeed at the margin [win:loss ratio to stay the same] . As retail margins are higher than institutional there will always be scope for B Book brokers to market their wares, and that the natural law will still see the majority of traders remain losers – and if there is an edge, it will disappear” said my friend.
“The new platforms now in play, mainly the new kid on the block = the hybrid block chain models or P2P trading are the electric cars of tomorrow with no third party between the trades + no client money sitting with the broker, add little value to the trade intelligence, more the broker cost base.”
Interesting times indeed. For retail traders, institutions, brokers, broker service providers, Introducing brokers, Liquidity Providers, education vendors, capital allocator platforms and thank the gods of the financial markets, as the current models are broken. “I think that regulatory arbitrage is not dead for the moment, APAC region is still in play” he said.
Concluding, as I pulled off the highway at Malibongwe Road into Bryanston, my concluded said “yes, to the retail trader, you cannot beat Mr Market, but you can make the world a better place.”
….and so began another fabulous week in fabulous South Africa.
Tuesday: IBs and the biggest, most underserved networks of good clients that exists
The triangle of conflict that exists between brokers, IBs and clients has been very difficult to unravel and as a result has continued as a status quo for many years.
I have spoken over the years to numerous IBs from all continents including Asia, Africa, Europe and North America, and most seem to share the same experience of having to exercise trepidation when structuring their business.
Until 2017, the IB could make significant lifetime revenues from an active client. In China some IBs are bigger then the host firms. The Chinese had refined this model to perfection until the communist government effected the same rules that it applies to all other overseas business and put an end to it.
Host firms in Europe which now find themselves under the MiFID II rulings have scrambled in desperation for market share, some of which are MetaTrader 4-based firms which struggle to differentiate themselves on home market territory and some are sophisticated companies with their own proprietary platforms and a very good quality reputation, and have bent over backwards to sign up IBs in China.
Many of these firms, some of the most notable being FXCM, FXDD, GKFX and Saxo Bank have have spent millions on marketing in China and getting these large IB firms to sign up. The Chinese model differs slightly with other models in that the UK and global firms have offered exclusive terms to the Chinese poured millions into them to get their business.
MiFiD II has changed all of this and a typical UK firm that has spent time and money developing the large IB network and now needs to declare everything to the clients.
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, therefore if the market on the Dow is 25520-25521 the the mark up will show 25520-25523 ( 2 pip mark up ).
For example, if a client opens $10 per point on the Dow. Normal spread paid = 25520-25521= $10 per point so $10 paid in spread. This represents a mark up of 25520-25523 which equals a 3 pip spread, and the client pays $10 per point pays $30 spread. Of this, $20 goes to the IB and $10 to the retail FX firm, hence the general stipulation by IBs 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 with MiFiD in place, as has caused 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.
I predicted a year and a half a go that there will 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. This means that the IB revenue model in 2018 post MiFiD should have been over. The revenues should have fallen 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.
However, what has actually happened is that some of the large firms have put an end to IB business altogether, but what has not been taken into account is how the huge networks of IBs which operate with the same firms outside their European bases is instrumental to the entire functionality of the retail FX industry.
Here in South Africa, the large companies have massive operational headquarters, with FSB regulation and are as important to their management as any office in Asia or Europe. The reason being that South Africa’s IB network is gigantic and very well organized, often operated by master IBs who represent the entire trading and investment portfolio of the smaller, satellite towns that they reside in, and have the total trust of their clients.
Whilst this is excellent, it means that the very same conflict is a concern for IBs. I met on Tuesday with several very high net worth IBs some at the Bryanston Country Club where our November IB conference will be held, and some in Pretoria, all of whom have operated their business for a very long time and every one of them explained the same issue, that being the trust that the IB has to have in the broker, because one problem created by a broker would cause the IB to carry the can with his clients and the broker to be completely scot free.
Some examples of recent unpleasant circumstances were discussed, such as brokerages jettisoning IBs with recurring commissions so that they don’t have to pay the commission, leaving client bases transferred directly to the brokerage without actually remunerating the IB, which in effect is an unofficial theft of intellectual property, and also IBs having to manage the relationship between giving their client the best execution whilst being remunerated on a volume basis by b-book brokerages.
All of the IBs I spoke to this week are very wary of b-book dealing desks, seeing them as unelected controllers of the IB’s business, and potential damagers of relationships between IB and end client in which only the broker gains and leaves the client and IB to conflict.
Therefore, there is huge opportunity in South Africa for agency brokerages with good quality execution and proper banking and custodian facilities to serve the quality IBs of South Africa well.
We will be hosting over 70 IBs in Johannesburg in November at the Bryanston Country Club, and they will be presented to by Scandinavian Capital Markets and Blackstone Futures, both very high quality companies with unique infrastructural models that actually spend time with the IBs on a personal level and have secure custodian services.
If you are an IB, join us. If you are thinking of moving your business to South Africa, now is a great time to do so. Gauteng means ‘Place of Gold’. Johannesburg’s modern gold rush is well and truly here.
Thursday: If you’re going to do it, do it right..
Yes, those may have been the words of the late, great George Michael nearly 40 years ago, however today this applies to brokerages looking at their current region and how to scale their business properly in light of regulatory advancement, especially in Australia.
During meetings on Thursday in Johannesburg, many of the high net worth traders I spoke to have been referring their own trading and accounts that they trade for others to large, MetaTrader 4 based brokerages which have always been good and stable in terms of service and product offering due to their sheer size.
IC Markets, for example, is an Australian firm which has been tremendously successful, and is one of MetaQuotes’ largest customers, with server licenses numbering into the late teens.
According to my own research which is echoed by many sources, the company’s revenues are approximately half a billion dollars per month (do please note that this is not a publicly reporting company so the numbers are based on research only and are not ratified or published by IC Markets).
That is a fortune and certainly positions the firm as one of the largest retail FX brokers in the world. Some of the IBs with significant client bases that I spoke to in South Africa this week hold IC Markets in esteem and consider their experiences to be very good, despite IC Markets being just a very large version of any other MetaTrader based brokerage, in that it does not have its own product range, infrastructure or IP and cannot tailor its service toward any specific B2B audience.
The interesting point raised is that many firms saw IC Markets as an example of a firm that is looking to remove itself from Australia and set up office offshore. That is likely to be because ASIC, the Australian regulator, has been systematically putting a stop to the activities of Australian brokerages operating in other regions from their ASIC regulated offices, and of course most brokerages in Australia, IC Markets included, have been tremendously successful providing good quality service to Chinese customers and are respected highly in China.
Moving offshore is something a lot of Australian brokerages are looking at, however it is yet another example of a quick ‘Heath Robinson’ solution to an existential and current issue rather than actually considering how to build for the future.
What created such a good image in the eyes of high net worth Chinese IBs was the Australian regulatory structure, highly well organized leadership and professionalism among Australian retail brokerages – an attribute which is absolutely clear to me and is abundant at our FinanceFeeds Sydney Cup events every few months – and the perception that Australia is effectively a modern, civilized and well run Anglophone democracy which is in the APAC region in terms of proximity and trade partnerships.
This is far too good a relationship to turn one’s back on, and yes, going to an island with no reputation may preserve existing client relationships but what about future ones of that magnitude?
If, which is very likely, the Chinese Communist Party decides to chop all inward and outward routes for FX business to non-Chinese firms, that would be catastrophic as it would be nigh on impossible to gain the business of high net worth IBs and asset managers in organized regions from a call center in the Philippines representing an MT4 white label brokerage with a shell company set up on an undeveloped island.
In South Africa, this was a topic of discourse for many IBs. All have agreed that brokers should either keep their ASIC license and re-invest the massive revenues that they make into their business in order to generate sustainability, or move to South Africa and get a license from the FSB.
I couldn’t agree more. South Africa has tremendously high quality infrastructure, some of the best Tier 1 banks in the world, a vast and active trading community and proper regulations the world recognizes as highly as ASIC or the FCA. It is the gateway to Africa, the bastion of civility in an entire, resource rich continent, is respected by Asia, the Middle East, India and Europe as culturally accepting and diverse, and has a wonderful lifestyle.
It is also an opportune place to recruit very skilled, English speaking staff who genuinely are good at their job. It also is quite rightly renowned for some of the best food in the world and I am often found late at night having a barbecue when in Johannesburg.
That, plus some investment in proprietary infrastructure, would build tremendous bridges with new regions whilst maintaining existing clients. Let’s remember that Chinese investors are flocking to South Africa at the moment, ergo they would likely trade their FX accounts which are made up of revenues from real estate projects with a well known broker with an office in Johannesburg.
Let’s kraak, as they say…
Friday: All new A350. Looks good to me!
I have a longstanding preference for Boeing aircraft over Airbus, largely as I consider the engineering prowess of Boeing to be superior to that of Airbus.
Whilst Airbus has spent the last 25 years concentrating on how to make ‘fly by wire’ hands off, airline cost effectiveness and fuel use a priority by removing the pilot’s interactions with the aircraft as much as possible, Boeing’s ethos is on engineering , stability , build quality and dynamics.
Yes, a 777 does have a sophisticated autopilot system but the servo that operates the landing gear isn’t strong enough to land automatically and keep is straight if you’re an experienced pilot with a 200 ft landing limit, therefore many 777 pilots simply knock off the auto land system 200ft before landing and land on the left wheel first , then use the rudder to straighten it out at low speed before planting the right side rear wheel. Next time you travel on a 777 see if you notice it when landing 🙂
However despite little things like that , the 777 is a magnificent aircraft despite being almost 30 years old, the 787 is a whole new world and the 747 is proof that they got it right first time and is a sort of aviation equivalent of the Jaguar XJ-S.
That aside, I was impressed this week by Ethiopian Airlines latest addition to its fleet – a new Airbus A350. Yes, I’m sure a 787 would be favorable on a long journey but this was a relatively short hop from Johannesburg to Addis Ababa which is 5 hours in the air.
Most airlines would use a 737 or A321 for this flight and as much as I have a preference for Boeing , a new A350 is far better than being cooped up on a 737. I was able to sleep, the full multi media system was right up to date and a wide body aircraft for a short distance is a welcome surprise.
I suppose it’s rather like arriving at a rental depot and being asked if you’d like a bottom of the range compact Lexus CT200 or a top of the range Ford Taurus V6 for the same price. I’d take the Ford any time.
Can’t really fault Ethiopian Airlines, they’re a super company with excellent service, very good food, brand new aircraft and very low fares, even if it means suffering a layover in Addis Ababa… and I do mean suffer.
For anyone who wants to learn more about how to structure their society or business, travel to Addis for a day, observe customer service , business ethic, and how everything works… and then do the exact opposite.
Wishing you all a great week ahead!