Were OTC FX firms really THAT reliant on low volatility? – Op-Ed

The tide has most certainly turned. Throughout the last year, global markets in almost every sector have been affected due to endless geopolitical activity, ensuing currency fluctuations affecting the spot FX markets, and varying prices of company stock and equities due to new circumstances based on PR and peacocking by big pharmaceutical companies over who can ride the ‘miracle’ vaccine wave first.

All of these factors have restored volatility to a global financial markets structure after over 25 years of stability, during which retail FX firms rose to prominence and were able to gradually make a profit based on the lack of drama and lack of political and corporate chaos in established regions where capital markets businesses flourish.

In 2013, Drew Niv, who at the time was CEO of FXCM, the company which he had founded and led to be the largest retail FX brokerage in the world, had said “We have not seen any volatility for over 20 years”.

That dynamic continued until March 2020, demonstrating the absolute security of the capital markets structure of the First World.

Now, as the nations which Chinese communism seeks to target and weaken submit and whose leaders do absolutely nothing except repeating the word ‘Covid’ all day ad nauseam, the uncertainty that was absent for so long is now back, and there are huge opportunities to make large sums of money in trading stock and currencies, however, there is also the potential to lose.

It has become common knowledge that market-making retail FX firms with warehouse execution models have generated huge revenues over the past year. Some of this has been demonstrated publicly as the retail FX companies that have their stock listed on the London Stock Exchange have to publicly report their revenues. CMC Markets had a record year which was reported in the last quarter of 2020, for example.

With b-booking – that being a term for executing trades in house rather than sending them to a Tier 1 liquidity provider which executes them on a live market with banks and institutional partners such as non-bank market makers – the destiny of a broker is in the hands of those which operate its dealing desk, and the inevitable demise of a client is also determined by the exact same method.

During times of extreme volatility, it has been apparent that many FX and CFD brokers which operate the B-book model have suffered platform outages, which in some cases have left clients unable to access their account and close positions, only to find that their positions get automatically closed out once their trade goes into negative equity.

Last month, when British publicly listed CFD firm IG Group experienced yet another platform outage, leaving clients out in the cold, FinanceFeeds got involved.

This particular outage which took place last month occurred around the same time as North American video games retailer GameStop became the focus of a trading war between amateurs and Wall Street pros. Both GameStop and AMC Entertainment have seen their share prices boom as amateur investors, fuelled by chat on social media, bought their shares.

Now, IG Group, one of the largest retail electronic trading companies in the world, is suspending 900 small-cap stocks, with clients given 30 days to unwind positions.

This is a very interesting move, and perhaps should be considered as somewhat reactionary to limitations, and shows that the spot OTC FX and CFD model now needs to be seriously adapted to suit today’s very different trading scenario.

Whether some OTC firms now may look to shift low cap stocks toward physical to free money on the balance sheet, which is one speculatory theory coming from within the industry this morning, or whether it is simply too much risk with regard to potential exposure for brokers which take a risk and operate a dealing desk with OTC products which are already being provided at very low margins to be able to compete with thousands of other white label market makers across the world, large and small, offering similarly inflexible product ranges via a b-book execution model.

There is no doubt that times have changed for almost every industry sector in the world since this time last year.

Nothing is as it was, and some say it never will be again, hence the need to evolve and create not only a sustainable environment for your brokerage, but also to ensure that the product ranges being offered are able to be executed reliably and that many traders have spent the past year with not only the time to concentrate on trading, but have become extremely experienced in seizing opportunities which no longer mean the ‘you against the house’ b-book model can cause a high percentage of client losses.

We are well and truly into the age at which the long-awaited shift toward genuine multi-asset product ranges is not just a way of attracting more astute traders with larger portfolios and attempting to use the well-honed knowledge and expertise in the OTC electronic trading sector to rival the professional platforms of Chicago, London and New York, but it is now an absolute necessity, as the cracks in the old model are now obvious.

Quite simply, brokers which do not connect to global markets via a variety of executing venues, will not be able to operate during times of day trading volatility without severe risk to their own business.

Surely a brokerage should be exactly that: a middle man. A facilitator of access to markets. It should not necessarily be a cash cow that cherry-picks against its traders and closes them out when volatility occurs.

Thus, we have gone from a period of needing to go down the multi-asset route as a mere evolution from novice traders with small deposits using a CPA model via affiliate marketing toward attracting a better quality of client base, to a period at which we need to offer multi-asset solutions as a method of sustaining the ability to execute during important times on critical and popular instruments, giving both brokers and clients the most ‘action’ within important trading periods.

The only way to do this is by connecting to multiple pools of liquidity, multiple executing venues and exchanges, and offering tens of thousands of instruments across all global markets.

Today, FinanceFeeds spoke to Roman Nalivayko, CEO of TraderEvolution Global on this matter. Mr Nalivayko explained, “It has been almost 20 years since the entry of many smaller brokerages into the retail market with off-the-shelf solutions geared toward spot FX trading, in which low entry barriers meant that all a firm needed was a logo, and they could begin marketing to clients.”

“Things now are very different indeed, and not just because of the market saturation of so many similar brokerages and white labels offering the same spot FX products on a b-book basis where the dealing desk takes a risk and internalizes trades, but because the market is no longer as it was for retail traders,” said Mr Nalivayko.

“Two specific things have taken place. The first is that over a long period of time, traders who were very new to electronic markets have become very experienced and now know how to analyze the market, how to use tools and how to know if they are being b-booked or closed out for a dubious reason, and the second is that the accessibility to global markets is no longer the far fetched preserve of professional traders with vast portfolios that it once was” he said.

“Brokers may not wish to spend a fortune on building and servicing their own in-house infrastructure, we know that it can cost over $100,000 per month in support costs to maintain an in-house system, but we also are aware that being able to own one’s own intellectual property, and offer genuine access to global markets without any bias and equally importantly have a continual connection with no outages during volatile day trading times, or points at which certain stock is on-trend as good quality traders will no longer tolerate brokerages fixing it so that they have it their way only,” said Mr Nalivayko.

“For all of these reasons, and the matter that exchange operators such as CME LiveVol and CBOE are angling products toward retail traders, and exchange groups have been buying into the OTC world for some time showing that the will to put a lot of OTC business onto exchange is definitely a matter of importance for big venues such as Deutsche Boerse and EUREX, the acquisitions of 360T and Hotspot FX being cases in point, brokers now can offer a much wider range of clients a full set of instruments which serve the current and future trading environment sustainably,” he said.

It is clear that brokerages wish to acquire a wider and more experienced set of traders. We know this by the efforts of retail brokers and prime of primes alike, two recent examples have been the FinanceFeeds London Thought Leadership Conference which took place two years ago at the Ned in London and consisted of hedge fund and wealth management companies alongside algo traders and quants from across Europe and America. These were the absolute target audience – and some existing customers – of Swedish brokerage Scandinavian Capital Markets, a firm that meets every client personally, and develops its service to suit each customer.

Last year, Advanced Markets held its Hedge Fund Expo, in which FX hedge fund experts, solutions providers and traders demonstrated the importance of brokerages going down the hedge fund route, where to establish and how to do so properly. This got huge attention.

Necessity is the mother of invention, goes the old adage. Now, this is more true than ever.