Those of you who trade with US stockbrokers may have noticed that over the past week trading via the major brokerages (with the exception of Fidelity) has become “free” as these firms eradicated brokerage from their business models. The impact on these firms’ share prices, ironically, was they were clobbered as a result of them making trading cheaper for investors; elsewhere a few fintechs looked nervously over their shoulder as their one big differentiator – no brokerage – disappeared before their eyes.

I happen not to be one, but there are people out there who believe that where the equities markets go so foreign exchange will, at some stage, follow – so could the no brokerage model come to FX?

At first glance it looks difficult because the different market structures mean that some venues do have an edge in terms of available liquidity in certain pairs and certain times of the day – surely that is worth paying for? Equally, while there is competition in the FX world it is very different to that in US equities, thanks mainly for the payment for flow model that exists in the latter.

It does make me smile that equities enthusiasts are so quick to attack the FX market for having spreads, when at the same time that market allows market makers to pay the brokers for their flow. Why are they doing that? Well it’s not out of charity, it’s because they can make money from the flow by executing on a spread (it can also be because a lot of retail-orientated flow in equities is known as “dumb” flow). Payment for flow, if it exists in FX, is normally something that a new platform does in trying to build liquidity, and it generally comes in the form of a discount of trading fees, rather than an explicit payment – even though a pedant could (rightly) argue the outcome is the same.

This model in equities is under threat from US regulators, having already been banned in some countries, which makes it a strange time to be cutting all brokerage because those same brokers are counting on being paid by the exchange or the market maker for the flow – if that is banned then where do they go for their revenues? The ideas that are being bandied about are nothing new; different services that customers can pay for like social trading models, stock lending and margin loans, as to whether they will make up for the lack of brokerage income, we shall see – it could be this is an industry ploy to take out the upstart fintechs who have disrupted the model by charging no fees before reverting to normal.

I am actually a little surprised that the no brokerage tactic hasn’t been tried more often in FX – when it has been, such as when Hotspot made a big noise about free trading, it is normally in minor currency pairs and has a minimal impact on the business beyond creating a few headlines. No one has yet taken the plunge to try it in their core markets but perhaps the time to try it is now?.

Currently we still exist in an environment is which the major LPs are connected to every venue and that, allied to the odd unique customer (and last look), is keeping many of these platforms alive. That could well change, however. As I argued a couple of weeks back there is a sense that people are becoming more choosy about where they connect on both buy and sell side, and this will lead to a squeeze on the weaker platform business models. While participants are connected to most platforms they may well be attracted by brokerage-free trading, but if those connections are cut, is that lure going to be enough to get them to connect again? There may be a short-term impact, but longer term? That is less clear.

There is also the broader environment to consider. There was considerable surprise at the size of the leap in FX activity reported by the BIS last month, especially the 20% increase in spot trading and that surprise is generated from the fact that most platforms are having a tough time of it in volume terms. Aside from two platforms that were very much in the initial growth phase in 2016, no platform saw an increase in activity to match the BIS growth, so clearly participants are embracing a different model. At some stage this has to squeeze those platforms that are struggling to make money – even if their owners do have deep pockets they are business people and not charities, if the revenues aren’t there they will make cuts. This means if one of these platforms is going to go brokerage-free, the time should be sooner than later.

As to whether such an initiative would work in FX, I tend to think it could, but it would take a resourceful and brave head of business to adopt it. I had a fascinating discussion with LMAX Exchange CEO David Mercer on stage at Forex Network Chicago (a report on which will be published later) during which he made the assertion that a business built upon institutional transactional flows is going to struggle to make money – the flow just isn’t there (or rather it is going to different business models). If you agree with that view – and P&L’s editor Galen Stops and I have discussed this before in our podcast and tend to agree) then perhaps one idea to kick a platform to the next level will be to get rid of brokerage? The impact, assuming the platform has the right business model, could be significant both for the platform itself and the broader industry.

Of course, the assumption I have been making here is that it will be a new(ish) platform that makes such a move if anyone does, but in reality the real disruption would come if a primary venue did it. One alternative business model is data and as was noted in a BIS Markets Group report last year, the primary venues are still the main source of price discovery.

Such a move by one of these venues could be a game changer because not only would it likely send shockwaves through those models reliant upon transactional flow, it should also attract a lot more flow to that platform. Both primary OTC FX venues have been in a prolonged period of decline in terms of their ADV and I have written before about the dangers of them becoming irrelevant with no obvious replacement, it strikes me that the approach taken by the equities brokers could be of interest to these venues as they seek to arrest – and reverse –  that decline.

So while I don’t think that FX needs to follow equities (in recent years I think it as actually been the other way around), this is one idea that could have legs – if a firm is brave enough to make the call. There exists a window of opportunity for such a strategy, but to make the move would be bold, it would be disruptive and it could seriously change the FX trading platform landscape.

Twitter @lamboPnL

Colin Lambert

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