Op Ed: Is there an FX broker that is too big to fail?

Never has a polarization made its presence felt more than that of the current retail FX industry’s seemingly insatiable hunger for high value acquisitions among the multinational giants compared to the concern which blights hundreds of other firms as to how to remain in business.

There comes a point within any business enterprise, regardless of industry sector, at which large conglomerates have amassed so many assets that the actual product that they sell is almost immaterial.

This has been apparent recently among companies as generic as motor manufacturers, whose end product often does not generate more than $5 profit per unit, but serves as a vehicle (if you’ll pardon the pun) for other products such as leasing agreements, maintenance contracts, as well as the revenue made from the array of smaller suppliers which submit their tender and are often forced down on price in order for a margin to be built into the end product.

Additionally, as demonstrated by Starbucks in North America, other items can be large real estate investments by firms that are not involved in real estate. Starbucks is not a firm whose coffee is renowned for its quality, nor is it especially profitable from its main business activity, however the company spent a number of years purchasing prime real estate, in main streets, often on corner positions, in which to set up shop.

This gave two advantages, the first being the investment itself, which included the ability to lease other parts of the building for residential and commercial purposes as well as the future appreciative value of the property, as well as positioning Starbucks coffee shops on intersections of major streets, where people often meet. Those who meet friends in their spare time “On Yonge and Finch” in Toronto, for example, will find a Starbucks – an ideal place to have a quick coffee whilst waiting. The same applies to Yonge and Eglinton, Yonge and Bloor and – well, you get the picture.

Practices such as this can only be conducted by extremely large firms with immense capital with which to invest in other interests. The question is, whilst small retail FX firms continue to assess their methods of client acquisition and retention in an increasingly competitive world in which retail clients are somewhat jaded and will only accept very low spreads, and in which introducing brokers expect an even larger piece of the action, and even more concerningly, online advertising campaigns cost a fortune and are often ineffective, can large firms which swallow up smaller niche companies and rivals like a shark among minnows, as well as maintain vast capital reserves, be completely immune to failure?

Recently, as this year’s prolonged and somewhat painstaking period of low trading activity across all FX segments continues, many retail firms are posting negative figures. Even publicly listed companies such as Hong Kong-focused firm KVB Kunlun’s board of directors have been advising shareholders to act with caution when handling company shares in the light of recent losses.

The pages of so many periodicals have been filled with volume results depicting low figures, with companies freezing recruitment drives, halting expansions and holding back until matters improve. Indeed, even some of the largest banks which are accountable for the lion’s share of global FX order flow, such as Barclays and HSBC have considered their options recently. Barclays had announced earlier this year that it was set to make 19,000 redundancies, a figure which is hard to even contemplate. In order to bolster flagging results, banks have begun to charge for benchmark order handling, a cost which will likely be passed on to an increasingly disgruntled client.

For these banks, the options are relatively scarce, as they were largely nationalized following the global financial crisis at the end of the last decade which saw the catastrophic failure of many of London and New York’s famous names as a result of liquidity crises and toxic debt.

This leaves the unflappable giants which dominate North America’s retail FX sector. In 2009, there were approximately 40 well represented FX firms in the United States, whereas by the end of last year, it was down to just nine. This year, we have witnessed the exodus of FXDD, and ILQ. The combination of extremely expensive regulatory costs, the large sums of net capital adequacy and the continual eagle eye of the National Futures Association with its willingness to clobber firms hard for infringements which often result in expensive lawsuits, added to the relative lack of business on the home market compared to the Far East, for example, has turned many companies away.

For GAIN Capital, FXCM and IBFX, success continues to prevail, despite the potential pitfalls and current business environment. FXCM and GAIN Capital have spent the last year accruing specialist companies in order to gain a foothold in existing niche markets, often for large sums, as well as buying their competitors, and taking on ready-made, established customer books from prominent firms.

Indeed, quite contrary to the experience felt by so many other firms, some of America’s largest companies are publishing results which are substantially higher than those of last year, which is a complete mirror image of pretty much the entire FX business worldwide, with many companies making record figures last summer and all time lows this summer. GAIN Capital, for example, has achieved average daily volumes in August this year which were an astonishing 42.3% higher than the same time last year.

By having such corporate buying power, companies such as GAIN Capital and FXCM can not only weather storms, but can invest in many diverse sectors, combine business efforts and publish group results which show high results

which are subsequently posted on the monthly and annual reports as publicly available information, which show figures such as the percentage increase in business which in turn drives share values. Perhaps if very few people read the entire report, share values can be influenced by pure percentage figures, without dissecting causes for this such as purchases of other firms and investment in diversification, thus giving companies who engage in this practice a significant advantage and even if the FX business of its own core operations is stagnant, profit still appears on the balance sheet and share prices continue to rise.

In the current retail FX landscape, it appears that the “Starbucks factor” is very much alive and well.

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