Raj Sitlani, co-founder of IS Prime and managing director of ISAM Capital Markets, sat down with Profit & Loss in Shanghai to talk about the challenges associated with expanding into Asian FX markets and why technology remains the key differentiator for prime-of-primes.
Profit & Loss: So what’s your business focus in Asia?
Raj Sitlani: We have a large market share in Australia but, until recently, never truly had the manpower or the resources to crack the broader Asia market. However, there’s a very big opportunity in the region for us to provide our flagship product – which is a prime-of-prime service with aggregated FX liquidity – and so last year we set up a Hong Kong office through which we can build out our presence in North Asia and China.
P&L: What is the biggest challenge for you as you look to do this?
RS: I think the biggest challenge that we have in North Asia is that there’s a lack of FX education amongst some of our potential clients. Right now, the prevailing approach amongst the brokers is that the best way to generate profits is simply to B Book all of their clients, because they think that these clients are likely to lose their cash very quickly.
In somewhere like China, this is exacerbated by the rebates that these firms are sometimes paying to the introducing brokers (IBs). Because the country is so vast, if a firm lands a substantial IB it can be the making of their business and so there’s very aggressive bidding going on between the retail brokers to get these IB accounts. As a result, the IBs sometimes charge enormous fees to the retail brokers and this in turn puts them under even more pressure to B Book clients and generate as much revenue off them as quickly as they can.
That’s why for every hundred yards of flow that exists in these markets, probably about ninety-nine of it is getting B Booked.
P&L: Is there any evidence that attitudes in these markets are beginning to change?
RS: Yes. One thing that we have in our toolkit is a risk analytics business – IS Risk Analytics – which we offer as a consultancy service amongst our other services enabling retail brokers to understand their FX flows better. It enables them to work out which flows are toxic and which are not, whether their clients are using copy software or social trading or algos, etc. In doing this, we help decision makers at these firms take a slightly more scientific approach to their business.
A lot of retail clients in Asia over-leverage themselves and they tend to have asymmetrical risk profiles, so they typically lose their money. Therefore the naïve view by the retail brokers is that by running everything into a warehouse book, they can make lots of money.
But now, with the greater proliferation of technology and increased transparency in the markets, brokers are starting to realise that perhaps they don’t have the expertise to deal with all of these flows. That’s why it can help them to have independent analysis showing them how they segmented their flows and also showing how they could have segmented it differently in order to improve their P&L.
In many cases, this analysis shows that actually it can be more profitable to STP some of this flow to the market where, ok, they’re not seeing the client drop – ie, the amount of money that the client loses – but they are still earning healthy spread on the inbound price and charging commission on top.
P&L: But what about the issue with the IB fees?
RS: Well again, what’s actually interesting here is that our analytics service enables us to show some retail brokers that they’re basically losing money because of the commercial deals that they’ve signed with the IBs. As time goes on, we’re seeing firms become more receptive to this message and realising that they can have a cleaner, more reputable business model.
P&L: What specifically do you mean by this last point?
RS: Well firstly, some of these retail brokers will try to compete and win business based on the leverage that they’re offering, so they end up providing retail clients with more leverage than is appropriate. At IS Prime, we’ve truly drawn a very, very thick line in the sand beyond which we’re not prepared to go when it comes to leverage because we just don’t think it’s prudent.
Secondly, with everyone B Booking trades, the market is too opaque and could draw regulatory attention as a result. If a retail client loses money, it might not be apparent to them why they lost this money and the retail broker might in turn struggle to prove exactly what happened with the trade.
By contrast, with the model we offer to retail brokers – if a client complains about slippage or price spikes, whatever it might be – we can provide the entire audit trail from when they clicked, to when that order hit the broker’s server, from when that order went from their servers and hit our aggregation when it went to the Street and all the way back again. And we will categorically demonstrate the trades are going to an LP.
P&L: So do you think there will be a move to this “cleaner” business model then in China and North Asia more broadly?
RS: I think it will probably take a while to really shift, but we’re just very slightly beginning to see the needle move now. Having a presence in the region is key, which is why we set up IS Prime Hong Kong last year.
We’ve seen in other jurisdictions that regulators can accelerate this process, by either banning B Booking or by stating that if you’re taking risk on your books, then the amount of capital that you need to hold in reserve as a retail broker is many times more than those who are not taking risk. So if the regulators in this region decide they want to make this market more transparent, then we could see a change take place much faster.
P&L: You’re hardly the first FX firm to spot an opportunity in this corner of the world, what do you think differentiates your offering?
RS: Our edge is the technology that we deploy and the people we have. Our mantra is very simple: we have to look after our liquidity providers and make sure that they make money. This isn’t to say that we give them a free ride, but it’s our job to say: ‘Here’s some good flow, here’s some bad flow and here’s some ugly flow’ and as long as, net-net, they can make money off these flows at the end of the month, then we’ve done a good job.
A lot of banks are still very much in a risk-off sort of environment, their hold times for keeping risk have been greatly reduced. So they’ve got to make their money in a very short window, meaning that the second they’ve got a trade, their systems have to decide pretty much instantly whether to keep the trade and warehouse the risk or skew out of it. Our job is to make sure that the flow they’re getting makes money for them and the reward for that to us is the tighter spreads that we get back from them.
But doing this is only possible if you have really intelligent technology. Not necessarily just fast, although that is one element of it, but really smart client segmentation or flow segmentation rules. And we have that technology.
P&L: Yes, but the LPs are only one side of the equation here, surely?
RS: Well what this means is that on the retail broker side, we can have a conversation with them about the makeup of their flow – the currency pairs their clients’ trade, what times of day they tend to trade, whether there’s a regional axe coming through based on their clients’ geographical locations, etc – then we put all that information into our technology and can figure out, almost to the order, which one is going to route into which aggregation.
So on the right hand side of the equation, we’re marrying up what’s coming in to what we’re sending out to the Street so that everyone has a smooth execution experience and there’s no disappointment on that side. Then on the left hand side of the equation, our bank and non-bank liquidity providers are happy because we’re presenting them with flow that they can make money off.
But that can only be done effectively if you have the right technology and enough brainpower behind it, and I think that’s where we can differentiate ourselves. And one of our longer-term goals is to build our own in-house aggregation.
P&L: So right now, how do you aggregate the flows?
RS: Right now we have off-the-shelf aggregation technology that we can write code into, but once we’ve built our in-house replacement, it will mean that our technology will be able to decide with literally any single order comes into our environment which liquidity provider it should be best suited for. That will be unique and will give us a further edge.
P&L: Does the liquidity itself still provide an edge? Lots of firms claim access to ‘unique liquidity’ but it generally seems to be same market makers on the other side in most cases.
RS: So yes, broadly speaking, most of the major prime-of-primes will have the same participating banks and non-banks. But while the makeup is not that unique, the way that orders are routed within the liquidity is.
Our technology allows us to choose an aggregation out of the many permutations of aggregations that would be possible mathematically. So there might be nine participants in a liquidity pool, but it doesn't mean all nine are competing for the same order at any one time. That’s because the order routing rules might, for example, know that a particular liquidity provider is weak in a specific currency pair and so that order would not go to one of our many aggregations which contains that liquidity provider, because we don’t think they will compete for it to win the business.
So that's where the uniqueness comes in, it’s the ability to finesse the order and make sure it goes to the right liquidity providers, it’s almost sub-aggregation.
The only other thing I would add is that another area where our liquidity management is unique is that, as a result of being part of the ISAM group, we benefit from years of experience in building execution optimisation models. This means we execute trades with The Street more smartly than our peers. It enhances the above mentioned equation even further.