A longstanding problem in the foreign exchange industry has been defining “retail” from “small institutional” when it comes to end user customers. Some of the platforms that offer both break out numbers, as FXCM and Gain Capital do, others, such as LMAX Exchange welcome all users to its core venue.
I get the feeling that the definition between retail and small institutional has finally been nailed down, however another issue seems to be raising its head – and into the bargain bringing about a change in the market dynamic.
More and more you hear that “small institutional” clients are troublesome – not all of course, but definitely some of them. The source of this discontent is always the same – the customer is too clever by half and is making money out of the liquidity providers (LPs) on a too-regular basis. Clearly some counterparties in the FX market that the LPs would rather not see on a B2C basis, are managing to slip through the net disguised as “small institutional”.
When there were still blurred lines between retail and small institutional, LPs were happy to take the rough with the smooth, but the delineation between those two sectors, allied to better MIS at the LPs, has meant that some customers are being shunted off relationship venues and onto ECNs where they have no advantage. This move is being driven by the LPs who are telling the platform providers what they like and don’t like. When lines were blurred, there was enough money left on the table by the retail flow to compensate for the “clever” stuff – now it seems, the LPs are sorting the rough from the smooth.
It is, perhaps, an unforeseen consequence of fragmentation that the LPs can, to an extent, pick and choose their platforms of choice – and enforce that choice by telling the provider exactly whom they want to see. It has always been that way to a degree, but when there were fewer platforms the latter could point to a larger group of the LPs clients, which in turn gave them some leverage. That has now changed. Equally, in the retail and small institutional space, the typical client is probably not powerful enough to demand an LP streams to them on the venue of their choice as some of their larger brethren can do often on the back of a wider relationship with a bank in particular.
You can tell it has changed, for I am having more conversations with the new breed of platform provider, typically those that have come out of the retail space. The key phrase now appears to be “bespoke flow”. No longer, it seems, can a platform launch with a bunch of customers and have LPs link up automatically. Now, they have to show a “good” client list.
It seems to be going further than that however, for some of the platforms edging into the small institutional space from retail are finding their clients not to the liking of the LPs. This has seen several of them change tack and now seek to become, for wont of a better phrase, connectivity providers. In other words, they offer specific clients to specific LPs.
Again, this is not a new business concept, several platforms have been doing this work for years, but if does seem to becoming mainstream in the retail/small institutional world – the “acceptable” way of doing business.
The impact of this shift could be interesting, because it seems to fly in the face of conventional wisdom that platforms need a critical mass of clients to survive. It does strike me that by providing this “bespoke flow” all these providers are doing is pushing single clients into the arms of the single dealer platforms.
For those that have moved from the retail space and cannot find that critical mass, this could be a short-lived experiment. There seems to be a realisation in the industry that some of the traditional demarcation lines, especially between bank and retail clients need repairing. The regional brokers in the retail space are going well because they provide what is again regarded as an important buffer between wholesale and retail. True, in many jurisdictions these brokers have to adhere to some strict capital and leverage rules, but it could be that in the end they realise it is better to stay retail than it is to be a conduit for small institutional customers to make the journey from retail to single dealer platform.