Revolt against the b-book: Traders take IG to court; brokerage business fully embracess multi asset

It had to happen in the end.

Taboo subjects are only taboo because they are perpetrated by people or organizations that know very well that they are wrong or immoral, yet if they are a mainstay of everyday business, they are often skirted around or ignored so not to draw attention.

This has always been the case with the trade internalization model of execution. Indeed, the European regulatory authority ESMA even has a classification for this. Brokers which execute trades in house and do not use a prime of prime brokerage or a Tier 1 bank liquidity feed are called “systemic internalizers” officially, yet no retail broker calls itself a systemic internalizer.

Operating what is known as a b-book, that is executing trades on an internal dealing desk and creating a market between traders and broker is a practive that has existed for over three decades, however, it has become more prominent since the introduction of the MetaTrader 4 platform in 2004, as that particular solution was designed specifically to enable affiliate marketing companies to enter the retail FX sector via a closed, off the shelf platform that was initially designed for white label brands to market and attract clients via lead acquisition and then trade against them.

By the end of the 2000s, over a thousand unregulated brands offering the same spot FX products operated boiler room-style call centers in the Middle East, Russia and Cyprus, many of which had morphed from adult entertainment, home removal, casinos and mobile phone firms. All had expertise in lead acquisition and clients were not seen as financial markets participants, and the product was not viewed as a financial service. It was purely about living from the deposits of anyone who could be persuaded to deposit.

This led to a complete overhaul of the regulatory structure and a hugely increased level of awareness from regulators globally with regard to the inner workings of the electronic trading industry.

However, a hangover from that period is the dreaded b-book and profit sharing exercises in which vendors and brokers share client losses, and in which liquidity providers, marketing firms and strategic partners are incentivized via trade volume and revenue sharing agreements.

This goes absolutely against the ethos of electronic financial services. Brokers should be either passing trades directly to liquidity providers on a fee basis, or should be conducting risk management via correct price feeds provided by Tier 1 market makers and interbank dealers without profit sharing or sending flow to other brokers for a kick back, to hedge.

This has now all come to an absolute head, and a furore has quite rightly begun.

It took the huge increase in volatility surrounding the stock market recently to foment this, however no longer will our industry or its clients tolerate being treated as a cash cow with no voice.

The chaos that came about last week in which IG Group locked its clients out of its platform during a period of high volatility – an occurrence that has happened at least five times over the past year – led customers to be unable to contact the company and the potential risk of being closed out automatically and losing their account and capital.

FinanceFeeds intervened and IG Group, concerned about their image more than their clients, responded immediately and we put clients in touch with their senior management team.

A few days later, IG Group suspended the opening of new accounts, and the company’s management team reached out to FinanceFeeds to explain this matter, and did so in an extremely concerned, almost grovelling fashion, admitting that the inability for clients to access their accounts and the stonewalling of customers by not accepting telephone calls was unacceptable and that the company is working hard to resolve this.

During that call, FinanceFeeds explained that as long as b-booking takes place, a conflict of interest between client and broker will always be there, and therefore outages at times that benefit a broker such as volatile markets will always be an issue, thus it is never in the best interest of a client and does not represent best execution practice.

IG Group vehemently emphasized that it does not operate a b-book, however it is of course well known that it is a retail CFD and spread betting company.

Subsequent to our conversation, it transpired that IG Group, along with a series of other market makers including Robinhood and Citadel Securities, are the subject of litigation in the United States for their behavior toward clients which is being alleged by traders in a class action lawsuit as conspiring against traders to prevent the market from operating freely.

The traders behind the class action suit invested in 12 stocks, one of which was the infamous GameStop, and are accusing the market makers of acquiring short positions, exposing them to huge losses running into the billions of dollars collectively. According to the litigation, 35 firms conspired to prevent retail traders from buying any further stock and forcing them to sell their stocks to artificially suppress stock prices of the stocks. On January 27, 2021, after the close of the stock market and before the open of the market the next day, the brokers and hedge funds in the suit coordinated and planned increased short volumes in anticipation of short calls on the following day.

This, in layman’s terms, exposes the real reason why trading restrictions were imposed by brokers, and should resound with anyone who was unable to access their IG Group platform last week.

During the call with IG Group yesterday, the company’s senior management placed blame on the firm’s infrastructure, saying that it was ‘working tirelessly to improve and resolve this matter and increase capacity to answer calls.”

I have personally seen how large IG’s customer service department is, and how well run it is, and the company’s platform is the result of a huge and ongoing investment and is one of the most reliable in the industry.

What, therefore is really going on here?

FinanceFeeds yesterday reached out to IG Group about this matter, but no reply was forthcoming.

Interestingly, Citadel Securities, a non-bank market maker which has taken a substantial percentage of Tier 1 FX order flow from banks over recent years is one of the accused conspirators. There is, however, no mention of XTX Markets, and the quality shows clearly as XTX Markets is in the number one slot for FX market share globally, higher than all of the Tier 1 banks. Brokers and prime of primes know clearly which firms are doing their job properly.

Some of those at the top are beginning to speak out. Alexander Gerko wrote a piece on LinkedIn highlighting the fiasco with Robinhood and making important points that are of wider interest to the electronic trading industry. FinanceFeeds reached out to Mr Gerko for more views on this matter, and we would most certainly appeal to Mr Gerko to send his message to a broader audience.

Mr Gerko founded XTX Markets in 2015, and by 2019, the firm had garnered so much respect within the Tier 1 market making sector that his company is now ahead of Citigroup in terms of Tier 1 dealing, after a 17 year domination by Citigroup.

“Retail flow, in aggregate, in the long run, loses money, not because retail flow is “misinformed” but because retail flow is “random” and loses exactly the sum of spread and commissions” said Mr Gerko.

He continued “Retail flow is useful to the trading process to the extent that fundamental investors are able to interact with this liquidity, at least some of these losses on retail side propagate back into their 401(k)’s.”

“This connection between retail flow and fundamental investors is completely broken in the U.S., as losses of retail are fully offset by gains of wholesale market makers. “PFOF” is horrible because it creates incentives for retail brokers to ensure trading through their platform is as uninformed as possible to maximize how “valuable” flow is to the market makers. There is a reason why Robinhood flow historically attracted the highest PFOF” said Mr Gerko.

He continued “Free trading is a silly gimmick which just turns transparent costs into opaque ones, and incentivizes more noisy trading to the benefit of retail brokers and wholesale market makers. “Gamification” of a valuable function of asset pricing and capital allocation is even more disruptive to true price discovery and capital formation. “Price improvement” vs market that is artificially wide due to badly broken market structure is just disingenuous marketing. The way to get actual price improvement is to put retail flow on exchange where multiple trading firms and institutional investors and other retail orders would compete for it” said Mr Gerko.

Mr Gerko considers that the potential solutions are:

1. Force all retail flow on exchange, to allow it to interact with other retail and institutional flow

2. Remove the notion of quote protection. It is an extremely ineffective tool to prevent tradethroughs, and stifles innovation, while promoting market fragmentation

3. Allow exchanges to charge whatever they want for trading, mostly to move away from nonsensical “cents per share” pricing

4. Ban any kind of rebates or PFOF. Force exchanges to compete on innovative market models, not on minuscule price differences. Put pressure on excessive fragmentation of lit liquidity which costs investors billions

5. Introduce FTT of 10 bps for all trades. Taxing distortive and irrational activity means more money for more productive things in the economy and less distortive and irrational activity. Volume will decrease, but volume is not the same as liquidity, U.S. market does really well on the former, but not the latter.

6. Redesign minimum price increments, MIFID II style, to allow tick sizes to change as a function of liquidity and price level. Currently a lot of stocks have either artificially wide spread allowing for excess profits to market makers, while other stocks have spreads of hundreds of ticks, completely killing liquidity on top of book

He called this observation “Stop this game” which is absolutely appropriate, given that it is a double entendre.

Just two days ago, a senior institutional FX executive said to FinanceFeeds “Robinhood is dead, PFOF is dead”. That is for sure, and was inevitable to those who could see it and who have taken years of hard work to run their businesses properly.

Jeremy Kintslinger, Director at Global Prime FX in Australia this week aired his opinion on the matters running up to this.

“Is what FXCM did any different to countless retail brokers using the acronyms ECN, STP and NDD to imply that they dont operate a b-book?” he asked FinanceFeeds.

“If you were to poll most broker’s clients and ask them if they think their broker is a-book, most would say yes. We all know what the reality is. The cows are coming home to roost!” said Mr Kintslinger.

“On another note, TraderEvolution Global is a fantastic platform with an amazing team behind it” said Mr Kintslinger. “They even have their own channel in our Discord where our clients are able to interface with the TraderEvolution Global team directly. How’s that for direct market access (DMA)?!” said Mr Kintslinger.

“We got a few phone calls from AFR today on the same topic” said Mr Kintslinger. “This is only just getting started. I just wish we made more of a fuss earlier on. It’s been ten long amazing years but sadly no change in this matter, so here’s hoping for a better future for all participants” said Mr Kintslinger.

Regarding his own product range, Mr Kintslinger said “The TraderEvolution team interacts directly with Global Prime clients in our online Discord community. The transparency of the TraderEvolution team goes hand in hand with our business model, and the feedback loop this creates is beneficial to all parties. We’ve worked closely with the TraderEvolution team to integrate with TradingView and we are really excited to go live with the project. This will enable our clients to trade and manage their positions across both platforms. Viva la revolución!”

“You can imagine what would happen if your typical retail broker offered a room like this, they’d get ripped to shreds with complaints. Having our own community really helps to hold us accountable to our clients” he said.

That’s for sure.

Speaking to a senior FX industry executive in the institutional sector today, FinanceFeeds understands that there are even some institutional firms resorting to internalizing flow that they say is being processed to the live market. “They certainly should not be hedging with another counterparty. That’s similar to a b book broker offloading flow as per FXCM with EFFEX Capital, which resulted in their banishment from the US market in 2017” is the general consensus.

It has been a perhaps mildly arrogant view among many OTC firms that regulators do not understand execution models, therefore it would never come to light, however a bit of digging deep within the FX industry shows that this is not the case at all, and regulators in the United States, Britain, Singapore and and Australia, four of the most important regions for FX and electronic trading, understand fully that matched principal licensees who report a certain amount of trading volume cannot report profits to the effect that the b-book firms have been doing this year since volatility began, as they can only make money from disclosed transaction fees. The authorities know everything now, and it is a very different world to five years ago.

Australia led the way with the surveillance on a real time basis of brokerage activity using the First Derivatives solution which monitors all activity in order that any irregularities immediately show up. This has been an excellent tool in ensuring a good market in Australia.

The discourse within the FX industry surrounding this matter is now huge. It is time we all did our bit to ensure good practice. The opportunities are there, as are the market is absolutely ready for brokerages to properly operate and not hide behind a warehouse model and hang clients out to dry when the market doesn’t suit the broker.

This is electronic financial services, not a fruit machine in a local pub.