Is retail FX heading on-exchange? Divisa Head of US Sales Ryan Gagne elaborates

In the FX industry, one year is a very long time.

Major technology providers NASDAQ OMX and CME Group Inc (NASDAQ:CME) began to spearhead the development of exchange-traded FX for the institutional sector in the United States in March 2014,

The retail FX industry’s predilection for OTC execution continued completely uninterrupted, and remained an unattractive proposition for retail brokerages.. until now.

Within a very short time frame, the discussion which began with the large vendors and exchange infrastructure providers has not only reopened, but has become a very clear priority of a wealth of industry participants, and in particular, liquidity and technology firms whose clients are retail FX brokerages.

Exchange-traded FX was largely regarded as an unpopular model for retail firms due to reasons which include the requirement to pay exchange membership fees which are massive and often prohibitive to retail FX firms which are constantly having to keep their spread down and therefore would be unable to monetize such a model.

Additionally, the cost of adding another layer to the trading infrastructure is costly and integration is a consideration.

These considerations, added to the recent interest in the exchange model due to the facilitation of transparency and efficiency for liquidity distribution, have given rise to a new type of platform, which acts as an exchange, but does not have the associated costs and barriers.

As far as liquidity provision is concerned, there are so many liquidity providers available that aggregating them all is not a simple task, therefore operating an exchange type model would facilitate an easier interface between liquidity flow, brokers and end users.

At last week’s FXIC conference hosted by Shift Forex in New York, there was a remarkable focus on the development of the exchange model for retail platforms, and to elaborate further, LeapRate spoke to Ryan Gagne, Head of US Sales at Divisa, which is a company that has onboarded FastMatch’s otcXchange solution.

There could be a number of significant advantages for brokers, platform firms and technology providers alike should exchange-traded FX become de rigeur.

For integration companies, a two-fold revenue stream could ensue, as brokerages continue to pay volume-based charges for the use of bridges and connectivity, whilst exchanges wishing to facilitate the connection of various platforms and users to their service may also pay a fee to integration companies as a means of connecting users to exchanges without the great expense and support costs of directly connecting individual platforms.

For retail users, exchange-model platforms which are dedicated to this purpose would reduce the cost to a fraction of that chargeable by a regular exchange, and still provide transparency, whilst regulatory inspections would be made easy as compliance officers can pull prices off an exchange at any time, to ascertain how they were calculated and executed.

Divisa’s foray into this critical arena at a critical time is indeed interesting, as Mr. Gagne explains.

Please elaborate on the factors that lead to the development of Divisa’s new otcXchange platform, and how it is likely to be positioned, among which companies, in the US market.

Divisa sought out the most robust technology available in the foreign exchange market. The technology is fast, operating in microseconds versus the millisecond benchmarks of other FX platforms. With multiple co-location sites globally, regional latency is nearly eliminated.

Additionally, we offer connections via FIX 4.2, 4.4 and Binary code. The platform supports a vastly expanded array of more than 30 order types thanks to FIX 4.4 thus, enabling new algorithmic trading strategies that still today are not yet available on other electronic FX venues.

Last year, some of the major institutional technology providers including NASDAQ OMX and CME made steps toward pioneering exchange-traded FX as a mainstay of the institutional sector. Can you see a point when the US regulators will rule that all FX should be traded via an exchange?

In as much as some would like this, I think that a mandatory migration to pure exchange based trading may be too extreme for a number of reasons. However, considering self-regulation is itself the premise of how spot and FX futures are overseen, I see the industry evolving, quite rapidly to more exchange style or ECN traded spot FX.

The exchange style or ECN method of trading FX isn’t a new “whiz-bang” idea; these are systems that have grabbed a major foothold in spot FX trading since their entrance to the market in the early 2000’s.

What are the considerations for providing exchange-traded FX? Can a brokerage remain competitive in terms of connectivity and latency bearing in mind that another layer is added to the execution funnel, and is cost comparable considering that an exchange has to be capitalized?

Three key considerations that are a must for providing exchange traded style FX; disclosure, anonymity, and transparency. Disclosing the type of trading that is conducted, whether “Last look” or No last look”, keeping names out of the picture and permitting honest and consistent pricing to all participants are paramount.

Remaining competitive in a particular exchange or ECN is a decision made by each and every participant; buy side or sell side, co-location, network connectivity are critical factors and are benefits for firms that pay the premium. However and this needs to be kept in mind, an electronic exchange itself does not layer latency into the picture for their participants.

Would it take more time for a price taker (buy side) to get a rate and execute with a price maker (sell side)? Perhaps, but in some cases it may actually speed up the process. For example, as an exchange participant (maker or taker) you have 1 single connection to manage whereas a buy side would have to support numerous connections to varied data centers to get the same level of pricing.

Also keep in mind that a very robust aggregation system would have to layered and managed into the mix for that firm and let’s not even get into managing all of the clearing relationships that same firm would have.

What are the costs per million of operating via Divisa’s otcXchangeTM platform compared to a standard OTC platform, and what components are needed?

Divisa operates in a very simple, invoice-free model with a single markup to the rates displayed within otcXchange. All takers receive the same mark-up and there is no fee to the makers.

Do brokerages and liquidity takers using the platform have the chance to conduct their own risk management, or is the entire order flow processed via the exchange directly to liquidity providers?

Any participant making use of otcXchangeTM is managing their own risk elsewhere. Divisa’s otcXchange is the venue itself where the trade is conducted. How the participant came to the decision to execute the trade, whether it is due to offsetting risk from their “B book”, trading strategy, hedging strategy or whatever else, is all on that participants. We are just the marketplace to facilitate the deal.

The NFA is looking closely at transparency and creating honest markets in FX. Do you consider the exchange model to be the solution to maintaining equilibrium between broker profit, client protection and regulatory adherance?

Yes, there is an equilibrium it is demonstrated daily across markets worldwide; equity, futures, bond, bullion markets all operate in this manner today, there is no reason FX cannot come up to speed and otcXchangeTM looks to help bridge that gap.

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