Surely, it is too good to be true. An offering that benefits everybody involved, enables large banks to leverage existing technology to attract flow from untapped sources, allows smaller banks to concentrate on sales without having to diversify into technology provision, and gives small banks’ clients a chance to enjoy access to more efficient and complex trading models without having to change their trading partners.
Magnus Allan looks at white labelling and asks: Where’s the snag?
Over the last five years, the banks that could afford to embarked upon a technology push that they are just now starting to enjoy the benefits from, such as faster trades and more attractive spreads for clients. The banks that could not afford this have watched, nervously, from the sidelines, fearing they will no longer be able to compete, that their liquidity would drain away and their clients would look elsewhere to take advantage of better technology and pricing. Or so it would seem.
The reality is, however, quite different. No matter how deep their pockets, institutions that have made large outlays on technology are looking at making the most of these investments.
By modifying in-house systems to provide external offerings, they can not only recoup some of the initial investment, but also attract more flow. Equally, those banks fearing disintermediation are able to offer their clients all of these benefits in their own name – a win/win situation if ever there was one.
White labelling as a concept is not new, banks such as Dresdner Kleinwort Wasserstein have provided liquidity downstream for some years, but it is now becoming a much more competitive arena as banks such as Citibank and UBS Warburg enter the fray.
Increasingly the leading tier of banks view white labelling as a means to increase market share, especially in the mainstream currencies. They are careful not to tread on their smaller brethren’s sensibilities by referring to the white label arrangement as a partnership rather than a client relationship, but in reality there are few smaller institutions happy to admit they outsource their FX pricing.
Perhaps the biggest argument put forward for white labelling is that by offering their systems down the chain, the big banks have the chance to attract flow from areas in which they might not operate due to credit risk issues, and this is where the relationship works at its most efficient in many eyes.
“From our point of view, it enables us to access certain markets where we may not have the client specific credit appetite or direct client contact,” says Vince O’Sullivan, director at Barclays Capital. “We can tap into the flow, utilising our existing relationships with local banks who maintain the underlying relationship with their clients.”
But, What is it?
At its most simple, white labelling is taking a bank’s system and rebranding it as another’s, all the partner bank has to think about is its client relationship and that its credit line is good. “Technology is extremely scalable and the bigger players are currently utilising their systems at well below operational capacity and as such are able to offer white label services,” says Allan McKenzie, head of business development for global foreign exchange, at Dresdner Kleinwort Wasserstein in London.
White labelling also offers resource benefits for smaller institutions. “Many banks see white labelling as a way of outsourcing the trading side of their operations so that they can concentrate their resources on the sales side,” says James Taylor, associate director at Barclays Capital. “That makes a lot of sense.”
Beyond the simple, we have/you want equation, things are a lot more complex. “The key to providing a white label system is to be very flexible and to completely meet the needs of partner banks,” says Rita Saverino, director at Deutsche Bank. “Partner banks can use us as a price provider or not, as a risk manager or not, and access our order management system or not.”
Even in pricing, which in theory would be a simple part of the equation, there has to be room for flexibility. “Ideally we would supply pricing for everything, but the reality can be more complex,” says O’Sullivan. “For example, if we were working with an Australian bank, they may wish to quote on Aud, Nzd, Jpy, but not on Gbp, Eur, Scandies, etc. They could price for the first three currencies and take our pricing for the rest. On top of that though, they may want to have our auto-pricing apply to their domestic currencies overnight. It is all about working with the client to get the best result.”
…And Why Now?
Like many technology-related offerings, white labelling has had its ups and downs, but recently circumstances have begun to drive serious uptake. “The technology boom has declined, but of course there is still the demand for efficiency,” says McKenzie. “Many operators have come to the conclusion that they cannot do everything, so they are forming alliances with organisations that can provide what they need.”
Without doubt, there are many in the lower and middle tiers of the market who have effectively given up on competing with the top tier in FX terms. The cost/benefit equation is simply not convincing enough to encourage senior management to spend what can prove to be huge sums in building the necessary technology infrastructure required merely to keep pace.
The systems provided by the big banks (and some vendors) also provide the technology to enable the smaller institutions to “spread” their clients, thereby ensuring that their FX operation runs on a “profit-only” basis.
As the competition for flow among the big banks has grown, technology has also stirred the pot. Five years ago, systems were created in-house with exclusive programming languages that could only communicate outside an organisation in a very limited fashion. If you wanted to bring in a white label system, you would have to ditch anything that you had already created or bought, because it would not be able to communicate with the new system, end of story.
It was never going to be acceptable to rip out entire systems, and as a result, white label developments were limited. Now, however, legacy systems are gradually being replaced with products that are being designed to be compatible, while at the same time, industry-wide language standards, while still diverse, are interoperable to a workable degree.
Several banks have developed their second or third generation systems with white labelling specifically in mind. Institutions such as Deutsche Bank have extended the concept by white labelling their order management systems to enable their partner banks to forward client orders, as we discuss elsewhere in this issue.
The increased acceptance and uptake of electronic trading has further supported the move towards white labelling. As corporates increasingly eschew telephone trading in favour of online services, smaller institutions are being forced into action. Even if they do not like it, these banks are beginning to accept the economic logic of adopting a system from another bank.
According to Chris Berry, managing director and head of global liquidity services at Deutsche Bank, there have been three factors that have given rise to the demand for white labelling over the last few months. “Firstly, the technology has changed, and it has become possible to provide streaming access to liquidity in markets where previously that was difficult, such as spot,” he says. “Secondly, there has been a change in attitude in institutions which lack global reach. They have accepted that they may not have access to the liquidity that higher banks enjoy, and they may not be able to compete in either their ability to manage risk or in technology. Finally, there is continuing consolidation of liquidity into a smaller number of institutions.”
Of course, it can be argued that white labelling may accelerate this consolidation of liquidity. Indeed it is a consistent worry that is aired when white labelling is discussed, because the technology could enable the big to get bigger, squeezing out smaller players. Whilst this is the nature of the markets, many believe that the big banks will, at some stage, have to consider the cost of being one of just a handful of liquidity providers.
Should this occur, their risk profile will inevitably change. As they grab more and more market share, the banks will be running commensurately bigger positions, but the liquidity available to them in an emergency situation – surely the ultimate test of any risk system – will be limited to their competitors. In terms of day-to-day operations, the practice of risk “warehousing” represents little threat to banks, but during times of market upheaval – which are normally driven by events outside of the market’s sphere of influence – the increased level of risk has inherent dangers.
These pages have already noted that liquidity is becoming a concern for the buy side. If market consolidation continues apace, it will also become an issue for those in the top tier of the sell side. No longer would they be able to tap into liquidity from mid-tier banks as they have traditionally done – first over the telephone or Reuters conversational dealing system, then over EBS or Reuters 2000-2 – because those banks would instead be their clients.
Notwithstanding these concerns, are we on the brink of a white labelling revolution? “Competition will not intensify at this stage because credit officers will sit on any big push,” says Brian Maccaba, managing director of Cognotec. “This will not be a replay of 1999-2000 with the Internet land grab, the world is far more cautious. The mentality is there, but even with an aggressive view, people will be looking three to five years down the line to get returns. The banks will be happy with the gradual approach because of the complexity of bringing the systems together. This will not be a short term land grab because there are so many interlinking banking systems to connect together.”
“This is not going to offer a six week payback,” he adds, “but it is the one area at the moment where long term strategic money is being spent in foreign exchange.”
O’Sullivan agrees, “A year ago, there was a drive towards STP, but now we can have an STP system up and running in a very short time. The two main areas where banks are concentrating right now are white labelling and prime brokerage.”
The question of disintermediation by the larger bank in the white label relationship is something those offering the product say will not happen. McKenzie points out that this is simply not in anybody’s best interests. “The real benefit of white labelling is that it opens us up to a market that we previously did not have access to by utilising other peoples’ sales forces. It is pretty much a win/win scenario; the credit intermediary gets to work with tools he might not otherwise have access to and we benefit from the flows.
“There will not be disintermediation because the intermediate organisation owns the relationship and the smaller banks and brokers have the ability to go deeper into a local market than we would want to,” he continues. “If a bank was looking to use this as a method of disintermediating in the market, its bank customers would take their business elsewhere. They are simply not going to hand over access to their customer base.”
Maccaba suggests that white label offerings will actually reintroduce an element of competition that has been threatened in recent years. “In many ways, white labelling will actually help sales organisations re-intermediate, because it enables the chain to operate more efficiently and enables a lot of organisations to become viable again. The theory five years ago was that the food chain would collapse and people would eat straight from the factory, as it were.”
“It is like a funnel or a hopper,” suggests McKenzie. “The intermediate people are needed to collect the flow and channel it in the right direction. You also need to take client attrition into account, an organisation would have to increase its sales force to go out and find new business.”
Taking in a white label system does not absolve the client bank from technological responsibility. “Clients need to know how they will deal with the technology set up and maintenance. Resources need to be allocated as they have to be the first line of contact for their clients,” says Barclays’ O’Sullivan. “For anonymity purposes we cannot support them all the way through.”
“Client anonymity is core to the concept of white labelling and partner banks will always need a basic level of client support, but the key is that they do not need to be continually spending money to make enhancements to their systems,” Deutsche’s Saverino concurs.
“There is a big difference between having full business continuation plans and being the first point of contact for clients. Client anonymity is core to this. They only need to support simple first line resolution,” she adds.
The level of technological support varies from client to client. Some organisations that are looking to take a white label system are simply looking to take pricing and add it to their own system, while others are keen to take a system in its entirety.
Both partners have to be certain that they are able to work together over the long term. One prospective recipient bank was apparently told that it would take two years for a white label system to be installed, presumably a gentleman’s excuse on the part of the provider, given that both Barclays and Deutsche say that they would be able to install a system within weeks.
Whilst it is widely argued that the credit factor is the key driver of white labelling, there are those who believe it is the very factor that could limit its expansion. This argument centres on the belief that only small regional banks are likely to be interested in a liquidity pipe from a bigger player to enhance their core expertise. This means that white labelling will be limited to a small group of banks in a small group (predominently emerging market) of nations. The key to a continued expansion of white labelling, therefore, lies in the leading banks’ ability to convince the middle tier of its benefits.
All organisations are aware that the relationship is key to take up. “White labelling is not as simple as buying a system that you can simply dump if it is not working the way that you want it,” observes Berry. “It is like a marriage: making sure that the partnership fits is very important for both sides, and that is why it is not being rushed into.”
“We have to pick our clients carefully, and they have to ask themselves who they think will be around in a few years’ time, and more importantly in the short term, who will work to resolve issues as if it was their own client base,” adds Saverino. “There is an investment on both sides.”
“It comes down to trust and the trading relationship,” says McKenzie. “Here, the early adopters have an advantage because it allows them to promote their brand and get into the market before there is too much competition. It is important to be able to ensure good service levels. A lot of trust is placed in us by the intermediary in the provision of service to his client.”
Where white labelling goes next depends very much upon how the banks’ core proprietary systems evolve, but given that white label offerings are simply a derivative of those proprietary systems, there is no reason to expect surprises. Banks talk about extending their services to other asset classes, however they acknowledge that the existence of efficient exchange-based trading platforms in many markets precludes such a move.
FX derivatives appears to be an area that exemplifies one of the key ingredients of a successful white label operation: you must have an advantage (in terms of market position) that you are willing to extend down the value chain.