Last Men Standing

FXCM’s forced exit from the US leaves only two major retail OTC FX-focused brokerages in the market. Galen Stops talks to the CEOs of these firms about what this means for the industry.

“The retail foreign exchange market has suffered a less than exemplary reputation for some time now,” concedes Vatsa Narasimha, CEO of Oanda.

The latest blow to the industry’s reputation comes as the US Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA) concluded that FXCM had defrauded its US customers, ordering it to withdraw from doing business in the country and fining the firm and its founding partners a total of $7 million.

Glenn Stevens, CEO of Gain, makes the case that this latest scandal in the retail FX market could prove beneficial to the industry in the long run and encourages a “bigger picture” view of this market.

“The truth is that this industry often gets looked at in pockets because there is a mix of global and regional providers and many different regulators overseeing this industry. This can cause people to lose perspective on the fact that the retail FX/CFD industry is really a global industry with hundreds of providers operating across numerous jurisdictions.

“Yes, FXCM was a prominent player in the US, and yes, the initial reaction to this is something of a black eye for the industry.But it does not reflect the industry as a whole. Retail FX activity has continued to grow over the past decade and is becoming a bigger piece of the total global liquidity pie.

“If cases like this prompt better practices for the remaining players and actually raise the bar for firms in the retail FX space, then I think that ultimately it can be beneficial to the industry,” he says.

Similarly, when the fine was announced, Oanda sent out a press release declaring that the action by these authorities was, in fact, “an extremely positive move”.

In a written response to questions from Profit & Loss, Narasimha says: “The recent actions of the [CFTC] demonstrates the ongoing commitment of regulators all over the world, who are sending a definitive message that generating profits at the expense of your clients will no longer be accepted.

“The CFTC decision is particularly significant, because it sends a clear directive that in order to operate in the US, brokers must create a fair and transparent arena in which retail clients can trade.”

Although perhaps staff at the CFTC might contest the implication that there was a time when generating profits at the expense of your clients was accepted market practice, Narasimha makes a good point about transparency.

This was also a theme in the original Oanda press release, when Narasimha said, “We believe the retail trading industry as a whole will benefit from a more transparent approach where brokers are held accountable for making questionable statements or falsely disclosing their interests”.

Time to End Last Look?

The problem is that it’s not entirely clear what the retail FX industry can do to make brokers more accountable for these things. When sending out the initial statement, a press person for Oanda said that Narasimha has strong views on how the retail trading industry needs to shape up to become more transparent, fair and supportive of investors and traders.

But when questioned by Profit & Loss about specific mechanisms for achieving this, Narasimha defers to the regulators to identify these mechanisms, adding that the industry needs to work with the regulators in order to help them achieve this. “As a market participant we recognise that it is the regulators who identify the mechanisms by which brokers are bound. Wewill continue to work with regulators all over the world in an effort to create a fair and transparent market in which clients can trade, safe in the knowledge their broker has their best interests at heart,” he says.

Equally, the head of a retail brokerage business that does not have a dealing desk, reveals, “Our local regulator is telling us to take stuff down from our website because they can’t prove we do what we say and they simply don’t trust us. Trust is hard won and easily lost, and it is really frustrating when something that had nothing to do with you negatively impacts on your business. I am not sure what the regulators can do to change things.

FXCM was a public company, subject to all the rules and regulations that this implies. It made regular investor presentations and earnings disclosures. It has a code of ethics for its employees, a set of corporate policies and guidelines and charters for its audit, compensation and corporate governance and nominating committees. All of which are available on the firm’s website.

It is overseen by a variety of regulators across the world, including the NFA and the CFTC in the US. The transparency mechanisms were all in place around the firm and, arguably, they worked. The firm – allegedly – made false statements to both clients and regulators and was ultimately found out and held accountable.

Regulators can’t stop firms from lying to them or their customers, they can only punish them when they find out that this has occurred. But there is something that they could do in order to prevent a case like this occurring again, and it comes back to a topic that has been discussed ad nauseam by the FX industry as a whole but still seems to have no clear resolution: last look.

According to the NFA’s complaint against FXCM, the firm was giving one particular market maker – Effex Capital – an advantage by enabling it to see what other firms were pricing and by prioritising it in its aggregator. Neither of these things by themselves necessarily disadvantaged FXCM’s retail clients, only the other liquidity providers.

Where the NFA complaint says that these retail clients were disadvantaged is when Effex used last look to give them unfavourable prices.

“Whether or not last look should be banned is a decision for the regulators, however, this is not a practice we engage in at Oanda,” says Narasimha.

Meanwhile, Stevens says that he sees no real need for last look in the retail space.

“On the retail FX side, the sizes being traded are unlikely to run into liquidity constraints or stress a system, plus retail providers typically offer “good in size” liquidity, which puts a cap on the maximum amount that can be traded off any given price,” he comments.

Blurring the Boundaries

With only two major retail OTC FX-focused brokerages left in the US, one of which doesn’t use last look and the other which says it is unnecessary, it’s probably time for regulators to step in and ban the practice.

Of course, if regulators do this it seems likely that it will intensify the debate in the wholesale space, especially considering how the line between the retail and wholesale FX markets has become more blurred in recent years. In fact, this is a trend that both Stevens and Narasimha predict will continue.

“Go back a decade ago, retail FX wasn’t even on the radar. But now it accounts for roughly 10% of the overall FX volumes; that’s a legitimate amount of flow and so I think that retail absolutely deserves its own seat at the table. Over time, I expect to see a convergence between the retail and institutional market anyway, because many of the tenets around access and transparency that are often available for institutional participants should be part of the retail market as well,” says Stevens.

Narasimha claims that FX is following developments that have occurred in the equity and fixed income market, noting that in both of these markets the combination of risk aversion from traditional bank liquidity providers and regulatory pressures created an opportunity for non-bank liquidity providers to step in.

“For example, in equities, equity derivatives and FI swaps, firms like Citadel Securities, Virtu and Susquehanna have all come to be the primary providers of liquidity in the absence of competition from the large traditional banks. Over the last decade, Citadel Securities has emerged as the largest global equities and equity option market maker, supplanting the banks, and in just three years they have also become the largest dollar swap market maker from a standing start.

“In the post-SNB FX space, there has been a reluctance from banks to provide consistent liquidity. This vacuum has allowed non-bank market makers to step in and gain market share, so organisations such as Citadel Securities, XTX, Sun Trading and Virtu have now become significant players in the space.

“With regards to FX brokers becoming involved in the institutional space, again this is just a reaction to banks exiting this segment of the market, especially the smaller institutional sector where it has become uneconomical for banks. We expect this trend to continue as banks continue to re-evaluate where they focus their capital and efforts,” says Narasimha.

This convergence could significantly complicate any potential regulatory proposal to ban last look from the retail FX market. Ultimately, the regulators will have to decide if they are comfortable with this convergence or whether they would like to see two more distinct markets in FX.

Less Competition

One thing that is clear is that with FXCM now banned from operating in the US, there is less choice for retail FX traders and less competition amongst the brokerages. Arguably, this is bad for the retail investor and yet good for the big brokerages still operating in this market.

Gain has acquired FXCM’s US customers, and while Narasimha says that while Oanda in no way sees the events surrounding the FXCM scandal as a bonus, he adds, “It’s fair to say a significant number of traders are exploring their options when choosing their primary FX broker right now”.

Despite this, Stevens makes the case that experiences in other markets show that consolidation isn’t necessarily a bad thing for customers in the retail space.

“Yes, there are only three major retail OTC FX firms left in the US now, but there is also the counter-power of the exchanges,

which offer currency products in many sizes,” he says. The third firm that Stevens refers to as a major retail OTC FX brokerage in the US is TD Ameritrade, which offers Forex trading through its Thinkorswim platform acquired in 2009.

He adds: “Also, a market doesn’t necessarily become less efficient or more detrimental to the client as it consolidates. If you look at the discount broker market there are only four or five major providers now, all this has done is drive service up, drive transparency up and push costs down. So it doesn’t have to be a bad thing,” he says.

Whether or not the regulatory action against FXCM, and this subsequent consolidation of OTC FX brokerages in the US, is a good thing for retail market participants will be borne out over time. But in the short-term it is clearly another dent in the reputation of the retail FX industry, and a concern if this market is really going to continue to become increasingly intertwined with the wholesale market.

Galen Stops

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