How much does trade execution REALLY cost, and why you are getting a good deal – Op Ed
In these days of very low profit margins within retail FX brokerages, countered by demand from traders for extremely fast and price-accurate execution, attention is being paid to how the execution cycle works at a higher level than any other time since the rise to prominence of retail FX. Brokers in the retail sector are […]
In these days of very low profit margins within retail FX brokerages, countered by demand from traders for extremely fast and price-accurate execution, attention is being paid to how the execution cycle works at a higher level than any other time since the rise to prominence of retail FX.
Brokers in the retail sector are now able to emulate an institutional trading experience, however there are factors that have arisen at an equally rapid pace as the proliferation of direct market access brokerages, such as the relunctance by Tier 1 bank to extend credit to prime brokerages, which has hampered the ability for brokerages which attract retail clients to access top quality liquidity.
That in itself has led to some of the more astute and avantgarde brokerage technology providers to generate innovative solutions to foster better prime of prime relationships and continue to provide best market liquidity to a retail audience despite Citigroup’s research having indicated that extending credit to OTC derivatives firms has a potential 56% default rate.
It is remarkable that the major hosting and integration companies in this industry have come up with solutions that provide comprehensive connectivity in what has become an expensive and rarified business.
In order to demonstrate this, FinanceFeeds investigated the real cost of execution, and what would occur if a small to medium sized retail brokerage attempted to establish connectivity on an individual basis.
As someone who spent his apprenticeship some 25 years ago configuring PBX switches and Cisco routers for bank trading desks, I can vouch for the progress of connectivity in the financial sector.
Indeed, back in 1991 the connectivity that I was providing was for the interbank sector, serving Tier 1 banks – the highest level of the liquidity hierarchy, all of which was connected by 10-bit 2 bayonet connectors and had software which killed errant packets that served to block the transfer of data that, even unhindered, is comparable in today’s terms to attempting to outpace a Corvette by riding a bicycle into a headwind.
It was expensive, too. Consultancy rates for outsourced professional services providers in Britain back in 1991 (such as British Telecom or MITEL – back then it was the telecoms providers that dominated rather than the big four professional services firms that have now extended their services to technology) were approximately £1600 per day, which, accounting for appreciation and inflation, is akin to £4,000 per day today.
Shortly after that period, retail FX trading began to emerge, Matchbook FX being one of the pioneers.
I spoke to Josh Levy, one of the founders of Matchbook FX recently in New York, who reflected on that inaugural period.
“We began at a very pivotal time” he said. I started at Goldman Sachs in 1994 straight out of university. The entire FX industry was going through a pivotal shift from traditional voice brokerage to electronic execution at the time” he recalled.
At that time, EBS [now the electronic brokerage division of British interdealer brokerage ICAP] was just beginning to emerge as the mainstay of liquidity … but only for certain pairs” said Mr. Levy.
“The Reuters Dealing system had a dominion over certain other pairs, and certain voice brokers controlled others.”
Mr. Levy recalled that the sea-change transition from voice to electronic systems accelerated with the late 1990s / early 2000’s internet and e-commerce explosion.
What was the market like right at the very beginning? Very exciting. In the late 1990’s the Asian currencies melted down – specifically the Thai Baht, Malaysian Ringett and Indonesian Rupiah, which helped propel USDJPY from the mid 80’s up to the mid 140s and then back down again amidst volatility that the FX markets have not seen since. Shortly thereafter, the Nasdaq and related equity markets exploded reaching their infamous apex in the spring of 2000″ – Josh Levy
“The whole game changed” said Mr. Levy. And amidst it all, firms such as Matchbook FX, as well as a few other pioneers such as CMC, GFT, Money-Garden (also known as MG Forex) Shalish Capital (now known as FXCM) and Midas (now known as Saxo Bank) where there at the very beginning.
Technology has evolved in leaps and bounds – however let’s remember those who were there from the beginning.
What if you tried to do it all yourself today?
FinanceFeeds research which was carried out using a custom crawler shows that today there are 1,231 active MetaTrader 4 entities currently operating.
It is very likely that at least half of those are white label license holders, which had paid $5,000 to MetaQuotes for the license and then a monthly volume-based fee to capitalize the platform and its hosting.
If this was bypassed, and a brokerage approached Equinix for a colocation service on an individual basis, this would cost…
Similarly, once having established a colocation provider, a separate relationship with a bank would be required, and the Tier 1 banks will either will no longer extend credit, or they will request much bigger balance sheets. $250,000 would easily get a Prime 5 years ago, we are now talking about minimum amounts in the $15 million if not $25 million or $100 million in some of the large Primes.
The end cost of all of this would be…. and that is without considering licensing, regulatory capital adequacy requirements, office rental and salaries for staff.
Essentially, the efficiency of the pricing of connectivity to live markets and the continual innovation with regard to how to package liquidity and distribute it is down to three companies, those being PrimeXM, oneZero and Gold-i, all of which serve the majority of direct market access brokerages in today’s industry and have a solution which ensures cost-effective operation.
Much attention is focused on bridge provision, and how the MetaTrader 4 platform was adapted to be able to operate with real market liquidity, following its original design in which it was intended to operate via an internal dealing desk with fixed spreads.
There is far more to the provision offered by these companies, however, because the method by which liquidity is distributed, by which hosting is covered, colocation and data center presence becomes not the concern of brokerages, and the end cost a fraction of what it would be if a broker attempted to establish connectivity relationships with data center providers directly for processing retail order flow.
In figurative terms, it is worth considering what the monthly cost would be if attempting to take on board the individual cost of colocation.
Research by FinanceFeeds has concluded that the cost of hosting at any of the major Equinix sites would average approximately $1700 per month for 20A or $2,200 per month with 40A, before bandwidth costs, if using a colocation expert such as Atlantic Metro or Radianz.
$1200 per month for a rack and $400 per month for 20A/120V is about right for Equinix NY4. It is worth remembering to include setup fees. Also, firms will need to consider the monthly recurring for the cross connects as well.
A senior executive within one particular firm in North America that I spoke to recently explained “We have a rack in NY4 and pay $1500/mo for a cabinet, $325 for fiber cross connect (each), $225 for copper (each), $450 for 20A 120v primary, $225 for 20A 120v secondary, + bandwidth which I might add I’ve found some places will charge you more per mbps in NY4 than they will NY2.”
It would require significant trading volume to make this viable, and even then, a dedicated team of technical support engineers to be able to liaise with the provider.
Speaking last month to Grant Foley, CFO of CMC Markets in London, I was informed that the cost of the development of the company’s proprietary platform was over $100 million, and the operating costs per month are around $150,000. This includes the relationship that the company has with its hosting center, as the firm has in-house servers that need top quality connection to the live market.
Very few brokerages in the retail market can conceive such a cost.
On this basis, the new ecosystem model that is being looked at by integration companies, with Andrew Ralich, CEO of oneZero having explained how $1 per million is achievable, dedicated to the retail sector is a welcome solution to access to prime of prime liquidity and fostering deeper relationships, as well as keeping the hosting costs down significantly.
We quite clearly are on the road to a very interesting connectivity direction in the coming months which will improve the trading experience despite the reluctance of Tier 1 banks to extend credit, whilst at the same time ensuring low costs to small to medium sized brokers.
Photography copyright FinanceFeeds.