It remains fashionable to deride the famous quote from New York Yankees’ legend Yogi Berra who once said, “It’s déjà vu all over again”, but in financial markets’ circles the admittedly mangled aphorism has value because technical analysis is very much the study of repeat events and economists expend much energy talking about an economic cycle.
While it could not exactly be described as a cycle, Gavin White, CEO of prime of prime (PoP) provider Invast Global, believes the world is currently witnessing something of a re-run from a century ago. “100 years ago, post World War 1, we saw a period of real prosperity and this, along with lax regulation, led to high leverage, irrational speculation and then a crash at the end of the 1920s,” he observes. “The crash was associated with easy money and the banks were particularly badly caught out, as asset prices plummeted. This eventually led to the passing of the Glass-Steagall Act in 1933 which saw the banks required to separate their trading activities from traditional banking businesses. Out of this came the creation of, or the blossoming of, dedicated investment banks such as Goldman Sachs and Bear Stearns.
“I feel we have been witnessing the same thing over the past few decades. Easy money and global de-regulation in the early 2000s cast the die for the Global Financial Crisis at the end of that decade and the eventual introduction of global regulatory reforms like Dodd-Frank and Basel. This time, though, the investment banks are themselves mainstream institutions and are in scope of the new regulations, particularly the capital requirements associated with the Basel reforms,” he continues. “This is creating a vacuum similar to that in 1933 when the investment banks stepped in and I see firms like ours, without the capital constraints, as the new generation that will grow into that vacuum.”
Although White is understandably conservative in his estimate of a 10-year vacuum – he points out that for 30 years after Glass-Steagall “nothing happened” and even when Republicans started agitating for a repeal in the 1960s it still took another 30 until President Bill Clinton repealed the Act – he has big aspirations for Invast Global.
“We have positioned ourselves at the sophisticated end of the PoP space and have invested in our people and technology to build a sustainable business model,” White says. “It starts from a different philosophy. Yes, we are in the volume game but we are not chasing volume for the sake of it – we want to build a strong and sustainable business and for us that means stringent risk management processes and only dealing with customers who are licensed in a major jurisdiction.
“We are emphatically not a retail business,” he adds. “A few years ago we were retail-orientated, but we didn’t just hang up a sign saying ‘prime of prime’ we made a conscious decision to change direction, to move away from retail and into the professional prime space.”
The PoP space is very crowded, as White concedes, but when asked about the difficulty in providing a real differentiator he is quick to point to Invast Global’s philosophy. “We are not conflicted in any way,” he stresses. “We are a source of expert advice to our clients.
“Transparency plays a big role,” he continues. “Our clients can see, pre-trade, which LPs are making their prices. They can see the LP names in their “depth of market” – I’m not sure other PoPs do that – and all LPs know their price is visible. This means we can’t slip or reject clients ourselves, because we are just a conduit. If any of our clients has an issue with an LP they are welcome to talk to us about it or talk to the LP direct.”
As part of its service Invast also provides post-trade feedback to clients and LPs. “We provide a weekly report on LPs that judges them in different ways, for example, how they performed in different currency pairs, spread comparison, response times, reject rates and market impact,” White explains. “This allows us to provide guidance and advice on the construct of the clients’ streams and how they can reduce slippage or market impact for example.”
As an example White says if Invast’s analysts are concerned that one client’s LP is very much in “quote and cover” mode, which will increase the client’s market impact, “We will advise the client of what was happening, share our analysis, and work with them to improve their execution experience, potentially replacing that LP with another,” he says.
Recently Invast Global hosted an exclusive cocktail evening, bringing together the top end of the FX industry from across the world to discuss the recently launched FX Global Code of Conduct which, White says, was a “great success”. He adds, “The Global Code is important to us because it helps promote good behaviour, which we think gives us an edge. The Code changes our relationship with our clients and our LPs and allows us to establish ourselves among the top tier providers. Being on the right side of the reputational divide is tremendously important to us.”
Alongside the commitment to good conduct, White is keen to stress Invast’s risk management processes, which he believes “are second to none”. Whereas traditional FX prime brokers offer a certain amount of NOP (net open position), Invast has dipped into the retail space for part of its process. “We utilise comprehensive pre-trade risk management processes and before that we have a stringent due diligence process to assess the creditworthiness of our potential clients. “We want to make sure we know our clients really well and monitor them in an ongoing basis,” he says.
White accepts that such an approach – allied with the firm’s refusal to take clients from certain jurisdictions until they have appropriate and robust registration processes – can potentially take away a lot of clients and volume, but he argues that looser standards is the short game. “We are here for the long run and we think our approach will pay off,” he says. “We only build market share when our PBs, the LPs and importantly ourselves, are happy with the customer.”
Equally, there could be an impact on the clients themselves. “Our clients are risk managed 24 hours a day, in real time, on a pre-trade basis – we are much more specific than the major PBs on this. Customers may feel this can occasionally restrict them but they have to get used to it because it is the cost of having a strong and stable credit platform. It’s the way the regulators want this industry to operate and we think our processes help our clients’ longevity.”
Threats and Opportunities
The prime of prime space has grown out of the regulatory change that has impacted banks more than any other financial sector – indeed White believes that most observers underestimated the impact on banks’ businesses – and this has led to an large reduction in the number of clients the banks were willing, or able, to handle.
It is in this flood of clients exiting banking relationships that White sees a great opportunity for Invast Global. “The major PBs are offboarding clients because of the costs associated with managing them, not the risks,” he asserts. “The problem is they have to have a prescribed amount of capital allocated to the business but too many customers just aren’t trading enough to make it cost effective. We don’t have the capital overheads, so we can cost-effectively service clients in this space and at the same time, we can remain as stringent in our due diligence and onboarding processes as any of the major PBs – in fact I would say our processes are more so.”
White adds that a great driver of Invast’s growth over the past three years has been their own prime brokers referring offboarded clients to them. “These clients have already been proven acceptable to the major PBs from a risk perspective and since we share our onboarding procedures with our three PBs they are happy to see the clients go to us,” he says, adding the observation that these PBs still see a lot of the flow in their trading business, it’s just via the Invast platform now.
As well as these existing customers, White says Invast is also seeing good growth from the increasing number of start ups in the hedge fund space as well as private traders stepping out of banks to push out on their own. “ MiFID II is likely to have a huge impact on economists and research analysts at the large banks,” he predicts. “Some clients will undoubtedly pay for their research, but you have to question whether the banks will need to retain the huge teams they have had previously.
“We are seeing a steady stream of analysts who have been marginalised in the banks by the regulatory change go their own way and this is a rich seam for us to mine because while they may not be managing hundreds of millions of dollars, their roots are in the professional market – they understand risk and the importance of managing it appropriately,” he adds.
As much as there are tremendous opportunities from the changing market demographic, White acknowledges the existence of threats – however he is quick to downplay them. “If the current trend of the major PBs cutting clients continues for some time at the same pace, then they may get to us and we could see our own credit lines at threat, but I don’t foresee this happening any time soon,” he says. “We enjoy long-term stable relationships with three tier-one PBs, so that should also help ensure the sustainability of our business.
“There is also the opposite risk that the industry reverses course and the major PBs start onboarding clients again in large numbers, but I also don’t see this happening for some time, if at all,” he continues. “Not only are there the capital issues, but the banks have all cut a lot of staff. Repopulating the desks will be expensive and time-consuming. They will also have to reinvest in their technology and I’m not sure the budgets are available at this time to support that process.”
Not insignificantly, White also questions the banks’ appetite for returning to the ‘flow house’ mentality in their prime services businesses. “Most major PBs have identified their core clients that they wish to have on their books and it seems clear there is a desire to have a smaller number of higher value clients.”
When asked about the prospect of losing clients because they become very successful, White expresses the hope this happens. “If our clients are very successful that is great,” he says. “Not only would this prove the strength of our model – which is as much about providing clients with the technology as it is the market access – but it would also help us to grow with them. And if they really do outstrip us, we will happily refer them to a major PB if that is what the client wants.
“Either way it would reflect the strength of our business model, which is an incubator of sorts for emerging managers and brokerages,” he adds.
With the regulatory impact unlikely to diminish – White observes that while the next iterations of Basel may not be as harsh as previously thought they certainly won’t be any easier than the current rules – there is an air of optimism around Invast Global. “I definitely think we are on the cusp of a new age in financial services,” White says. “Firms like us, who have invested heavily in their technology and analytics and chosen a very quant-driven approach, have a tremendous opportunity.
“Everything is driven by our belief that there is a long term change coming to the industry, mainly driven by regulatory reform that is not going away,” he reiterates. “We believe we are building the right product – one that is sustainable rather than opportunistic – and that our approach will help our clients build an equally sustainable and successful business.”