“Trade execution is a byproduct of being able to access the right liquidity, and of course companies need the right relationships to be able to obtain the right liquidity in the first place” – Richard Elston, CMC Markets
This week, the Financial Conduct Authority (FCA) has demonstrated its sloth-like approach to proposing new regulations for the electronic trading industry over which it provides a regulatory framework in Britain.
The British retail trading sector is among the largest in the world, and consists of large, mostly publicly listed entities which have been established for the best part of three decades, and specialize in very domestic market-specific products including contracts for difference (CFDs) and spread betting which require dedicated proprietary platforms.
It is very hard to argue against the patently clear reality that evergreen British giants such as CMC Markets, IG Group, Hargeaves Lansdown are vast and highly well organized corporations that fully understand how to conduct business in Britain, their loyal domestic client base and abilities of their well-structured and highly experienced senior management being absolute testimony to this.
The FCA’s new proposals to amend the rulings by which CFD products can be provided in Britain have been a massive subject of discussion this week, even to the point at which mainstream British news sources took to sensationalizing the potential outcome by implying that consumer and investor confidence was low, and emphasizing the sudden drop in share prices of the major spread betting and CFD companies in Britain, namely IG Group, CMC Markets and Plus500.
The FCA’set forth its plan which is to implement a package of measures intended to enhance consumer protection by limiting the risks of CFD products and ensuring that customers are better informed. The new measures include:
- Introducing standardised risk warnings and mandatory disclosure of profit-loss ratios on client accounts by all providers to better illustrate the risks and historical performance of these products.
- Setting lower leverage limits for inexperienced retail clients who do not have 12 months or more experience of active trading in CFDs, with a maximum of 25:1.
- Capping leverage at a maximum level of 50:1 for all retail clients and introducing lower leverage caps across different assets according to their risks. Some levels of leverage currently offered to retail customers exceed 200:1.
- Preventing providers from using any form of trading or account opening bonuses or benefits to promote CFD products.
As CFDs are a core product for most British firms, the proposals have a direct impact on the entire structure of British retail electronic trading, but why does this matter?
IG Group and CMC Markets are absolute household names in Britain, and whilst Hargreaves Lansdown is the largest financial services firm in the UK, its CFD platform HL Markets is a white label provided by IG Group.
British customers are loyal and astute, they understand their domestic market very well and are by and large careful and conservative investors and traders who study all aspects of the most effective methods of investing before doing so, and will often stick with the same firm for many years.
The average lifetime value of a customer of a MetaTrader 4 brokerage that offers spot FX is six months, and the average deposit (outside the United States) is $3800, yet it costs approximately $1200 to acquire each client, and margins and spreads are very low indeed.
In Britain, IG Group and CMC Markets have retail customers that have been loyal to their brokerage for several years, are familiar with proprietary CFD platforms and take a long term view. This is a far more sustainable model.
Two days ago, just hours after the FCA’s announcement of its proposals, IG Group, Britain’s second largest electronic trading and investments firm after Hargreaves Lansdown, which has a market capitalization of £2.25 billion, has experienced a tremendous 21.9% drop in share prices which went down to 614p per share.
Also affected is Plus500, the evergreen example of efficiency with no sales staff, very light operating costs and a digital marketing solution that is the envy of the entire retail business.
Plus500 took an astonishing 38% hit on its share prices this morning, taking its value down to £365 million. Just two years ago, this was a $1 billion company.
CMC Markets whose market capitalization is £406 million and has recently developed its next generation proprietary trading platform at a cost of $100 million, has experienced a 23% decline in share price on Tuesday.
Whilst investors are being over-cautious, it is clear that they are indeed experienced. Confidence in IG Group and CMC Markets’ ability to adapt correctly to this proposal was higher among investors than it was in Plus500.
This makes perfect sense, as Plus500 operates a fully automated digital acquisition model, which although is lauded as highly efficient in terms of client onboarding by many industry professionals, is not UK-centric and does not come with the pedigree and loyalty that is associated with the traditional British firms.
It is rather similar to the reference that British comedian Steve Coogan made in the 1990s as his most famous character Alan Partridge, when he described his then-new Lexus IS200 as a “Japanese Mercedes”. A Lexus is indeed that, whereas a Mercedes is always quintessentially a Mercedes, despite its faults which are numerous.
A Lexus is a more refined and better engineered product than a Mercedes, however it will never enjoy the customer loyalty that Mercedes-Benz does because it is not a household name.
Herein lies the important factor. Whilst the share prices of IG Group and CMC Markets currently languish, they will absolutely certainly rebound very quickly for a number of reasons, which is why now is the time to buy shares in both companies.
In May this year, I met with Grant Foley, Chief Financial Officer of CMC Markets, and marveled at the company’s next generation proprietary platform, which cost $100 million to develop, and is hosted and supported completely by CMC Markets.
Mr. Foley detailed its accurately considered development and inception, demonstrating that it is an absolutely cutting edge system, and rather like Saxo Bank’s leaning toward FinTech and continual expenditure on platform development, the most recent of which is the firm’s OpenAPI-based device-neutral SaxoTraderGo solution, the emphasis is on maintaining flagship status.
During the last few months which have entailed several meetings in London with the leaders of the British electronic trading industry, it is clear that many of the British firms have developed and refined their services toward the development of a trading environment which emulates the professional shops of the world’s largest economic superpower – America.
If America is the world’s largest proprietary and futures trading center, then England is the world’s largest OTC electronic trading center.
MetaTrader 4 was designed to be the user interface from which retail customers access a completely closed system, which in its early years meant trader vs dealing room in many cases, with no live market connected to the entire system.
Since the adoption of third party technology which has adapted the MetaTrader 4 platform to be able to be connected to aggregated liquidity feeds, many brokers now seek to onboard sophisticated retail traders, with direct market access and very fast execution, however it is still a yardstick short of the institutional model used in both Wall Street and State Street.
Yes, exchange listed derivatives are expensive to clear, because the market maker has to become a clearing member, which usually has two costs – membership fees which are upwards of $500,000 per year, and clearing costs which are several hundred thousands of dollars per month depending on volume.
British traders know and understand this, hence their predilection for CFDs.
Today, the share prices of the major CFD firms are beginning to climb, and it is absolutely clear that within a very short time they will be back to the high levels pre-announcement.
Last month, I met with Richard Elston, Head of Institutional at CMC Markets, who is a very well recognized industry leader, and highly experienced in Britain’s market topography.
Mr. Elston explained that there is a lot to consider when developing systems for CFD trading.
“With regard to trade execution, we are told that our execution is comparatively optimal versus some of the incumbents in the relationships we have had” said Mr. Elston.
“We hear this often with our CFD API, for example. Trade execution is a byproduct of being able to access the right liquidity, and of course companies need the right relationships to be able to obtain the right liquidity in the first place” – Richard Elston, Head of Institutional, CMC Markets.
Citing the Swiss National Bank’s removal of the 1.20 peg on the EURCHF pair in January 2015 as a major event that affects liquidity, Mr. Elston explained “Events such as the Swiss National Bank’s move to remove its peg with the Franc against the Euro dry up liquidity, dry up will, and also dry up enthusiasm.”
“Then you have an event such as Brexit in which everyone tries to manage their book during such a time, and sees the event coming but there are still low liquidty moments. To be able to obtain the right liquidity, companies need to have decent relationships, which can really be maintained by firstly having the right capitalization, and secondly to show the banks enough flow to make it worthwhile” – Richard Elston, Head of Institutional, CMCMarkets
“That doesn’t mean a firm has to give all business away” said Mr. Elston. Once you have the pricing you can then aggregate it to provide it through to the firms that take it” he explained.
“The richer a company is, the easier it becomes. The dice is loaded, and that’s the way it is. We can walk into a sales scenario and look at this. For example we could say a lot about whether technology is optimal to the client, but ultimately, with us it is transparency that is a major factor. We are a listed entity with over 20 years in this market, and that is what people want” said Mr. Elston.
Given that the FCA has taken the very easy route of clamping down on an established, well understood and popular asset class whilst allowing nefarious payment providers with sanctions by the US Treasury as money laundering operations on their record to continue to be endorsed by the regulator, and continues to allow offshore binary options fraudsters to con British citizens whilst other nations ban them outright, it is clear that the FCA is in some respects impotent, and is totally reliant on the good quality financial markets and technological ecosystem that powers the markets, developed and maintained by Britain’s urbane and sophisticated leaders for its progress.
Therefore, next time an announcement that seeks to change the dynamic of Britain’s FX industry is released by the FCA, it is wise to look away from the geography teacher mentality of the FCA and instead seek the wisdom and experience of Britain’s top level electronic trading firms.
I say buy, buy, buy….
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