The Last Look…

The time is rapidly approaching when sell side FX market participants have to consider another entry in the debit column – Bloomberg brokerage. This has been well-flagged so shouldn’t come as a surprise, but what I do find a little surprising is the industry’s absolute lack of reaction to the move.

Last year, when first writing about the introduction of brokerage fees on FXGO, I observed that the company would have done its analysis before such a headline move, and figured that the impact on the business would not be negative. This seems to be playing out, thanks to the inertia of its rivals, the challenge of the regulatory environment for some on the buy side, and the sell side’s inability to deliver a consensus on the move.

The latter is interesting because all sell side players are impacted, naturally, because, as always, they are the ones who have to pay the bill. I have spoken to large LPs who foresaw an additional $12-15 million per year in brokerage from the move, not something to be ignored, but beyond a few attempts to lure clients back to their own platforms, not much has actually been done

This is, according to more than a few people I have spoken to, because there is nowhere else to go without risking losing some clients for minimal reward. Firstly, this is because, as noted last year, Bloomberg has carefully priced to seemingly undercut its rivals in brokerage-only terms. Secondly, the firm is offering discounts, as flagged last year, to ease the burden, but thirdly, and most importantly, its rivals have sat back and done nothing.

There is genuine surprise that another platform hasn’t cut its prices to attract more business that might have gone to (or stayed on) Bloomberg. It could be that they are waiting for the “bill shock” associated with the first accounts from Bloomberg, but that seems to be a “too-little-too-late” strategy – clients cannot or will not move their business overnight, there has to be a business case drawn up and accepted for one thing.

I must confess that this does look like an opportunity missed by these firms, indeed I am told that some have actually ticked their prices higher, which is a tacit admission that, as I argued last year, they simply are not going to win any business from Bloomberg.

There is acknowledgement in certain buy side circles that the Bloomberg move puts pressure on the LPs, and this is something they are worried about, but, as noted, where do they go? People I have spoken to observe there is no value in pushing more volume down existing channels because the economics are no different, indeed often worse, for the LPs. More pertinently, whereas a year or two ago they might have investigated other technology aggregation solutions, now they won’t, because of fears over the Trading Perimeter regulation – or more accurately, the chance that the regulators may actually enforce it.

Certain aspects of the voice brokers’ business model, notably how they had two criteria for discounts, are equally, if not more, valid in the current environment

This leaves us with the status quo that I predicted last year – everyone knows it’s happening, but no-one is actually doing anything about it. This could be because times are good, we have volatility and heightened volumes, which is great for just about everyone in the industry (certain buy side firms excepted), but it could also be lethargy and an unwillingness to make what would undoubtedly be a risky business decision in some quarters.

While the focus is naturally upon what others could have done to challenge Bloomberg, there is also one area where the firm itself could enhance its offering. All platforms offer discounts – this goes back to the days of the voice broker – and these, naturally, benefit the busier players, which is how it has always been done.

There is one element from the voice broking days (I am talking spot obviously – the business continues to thrive in other products) that could be tapped into by Bloomberg, and indeed by other platforms – currency-specific targets.

I make no apologies for going “old school” again, because certain aspects of the business model from then would work today, notably how the voice brokers had two criteria for discounts, both of which are equally, if not more, valid in the current environment.

The first was the overall value of the firm to the broker (platform), but the second was a currency pair specific value. As an example, I worked on a desk where Cable was the busiest book by far. Overall, our bank was of reasonable value to the broking firms, but not to the degree of the absolute giants who were in every market (even USD/CHF which most of us tried to avoid!). The Cable book, however, was valuable, and this was reflected in a discount for that book, with that broker. USD/DEM (look it up kids) and USD/JPY didn’t receive discounts – they weren’t busy enough, but Cable (and GBP/DEM) did.

Transfer this to today’s market; are regional specialists being recognised for the contribution in certain pairs? Is the percentage of volume in the AUD or Scandis, for example, being taken into account? Talking to several of these players, with the odd honourable exception, the platforms are not accounting for this – and neither, at this stage, is Bloomberg.

This heightens the risk of driving out the smaller players – who are already pressured – because too many discount schemes are based upon absolute volume. It strikes me that a fairer way, and to help ensure a platform offers a truly diverse pool of LPs, is to give extra credits for liquidity in a specialist currency. That way, a local specialist can remain competitive.

As things stand, we could have the very strange situation where a local specialist and a global player have an agreement on outsourcing certain pairs, but the global player, because of the discount, is more competitive in the specialist’s pairs. This could lead to the specialist player quoting for the same business from the global player, that it could have won from the end client. In broad terms, there would be no real impact on the market, but how long would the specialist player bother to compete? This would be a problem for the buy side, and one that a growing number of them are aware of.

One can debate whether a bunch of prop firms actually provide decent liquidity, but the assumption that the banks have been squeezed and cannot take up the slack is worrying

As has been noted in these pages before, a healthy FX market needs a spread of LPs if clients are to maintain a decent panel of banks. It is ironic that in the past, platforms used to boast about the number of LPs they had, when the reality of their discounting schemes have often served to make a huge percentage of that number irrelevant.

There is a bigger issue at play here as well, one that the buy side should be concerned about and to which I referred in this recent column – the importance of risk-absorption in FX markets. Many of you will have seen the story that HSBC is considering outsourcing certain fixed income trading to a third-party. My view is the bank has rarely been at the cutting edge of single-dealer platform technology, but this is quite a statement, to effectively say there is no point in investing further in the tech, at least to the level required to stay competitive in certain fixed income markets.

This is a prime example of how regulation is undermining some markets, and while FX remains largely immune from its effects, in spot anyway, that is not to say it will remain so in the future. As I noted the other week, we need to keep the banks, especially the risk absorption providers, alive, otherwise we could have a very tricky situation in a market that is, after all, dedicated to oiling the wheels of global trade and investment flows.

I found it notable that in our story about the latest Acuiti survey of derivative-trading prop firms, some argued that liquidity will suffer if these firms are pushed out of Europe. One can debate whether a bunch of prop firms actually provide decent liquidity, but this highlights the reality of the regulatory regime – the assumption is that banks have been squeezed and cannot take up the slack.

That is a structural weakness in those markets, do we want the same in FX? I would argue “no”, and that we need a healthy spread of LPs, and platforms that are genuinely competitive on price. The platforms themselves also need to consider how healthy it is for their future if the market consolidates further due to their brokerage schemes – at what stage do we get to the point where a small group of LPs can dictate to the platforms? Yes, the customer base is a key bargaining chip for these platforms, but it remains a balance of power, and a very small, concentrated, group of risk absorbing LPs shifts that considerably.

The gravy train offers a smooth ride at the moment, but if too much pressure is applied, it will hit the buffers at some stage, and everyone will be affected.

colin@thefullfx.com