THE WAY FORWARD.
Mr Marco Baggioli, COO and Executive Managing Director of ADS Securities Global Brokerage spoke to Best Execution about why the FX industry must learn the lessons of history.
In past interviews you have talked about how the industry is in need of rebalancing due to the cost of capital and trading, the response to the Swiss National Bank action and other black swan market events. How have these issues impacted the industry?
Global forex markets are still feeling the impact of the Swiss National Bank’s decision to remove its peg to the euro, which happened in January 2015. The immediate fallout was the loss of a number of significant FX Prime Brokerages which has pushed up the cost of credit and significantly reduced margins across the industry.
If we look back at why the SNB crash caused so many problems, it was down to the levels of risk being taken in the market. A lack of capitalisation led to a number of brokers collapsing. The question for me is whether firms have learnt from this lesson, and the answer is ‘no’. There are still firms trading with extremely high levels of leverage making them vulnerable to any future market crash.
For all traders the cost of credit has continued to increase, but these increased costs are not being reflected in the trading prices brokers are quoting. This can only mean that they are still taking on excessive risk.
What impact is regulation having on the industry including MiFID II, EMIR and the FCA recent asset management report?
At ADS Securities, we have always welcomed the introduction of legislation and we have also said that the industry should be self-regulating. The issue will always be that the types of firm which cause the problems are the ones that do not comply with the regulations, and continue to take on risk that is disproportionate to their market strength. The more the industry steps back and regulators have to act, the less certain the outcome.
How is the industry responding and is it going in the right direction? If not, what path should it be taking?
The concern I have, and it is a view I have expressed before, is that there is too much risk in the FX industry. Many clients have not learned their lesson. They are still choosing a broker based on who provides the lowest price, ignoring the fact that the firm may have very limited capital backing their trading. After many, many years in the banking industry I am astonished at the FX market and how it is not learning the lessons of the SNB. It continues to chase cheap pricing instead of looking at the strength and security of their trading partners.
How do you see the playing field change – will participants withdraw and which new players will be coming into the market?
Our response to the market dynamics has been to put a lot of time and investment into developing our Prime of Prime (PoP) service. This is a true PoP offering, which allows ADS to act as an intermediary providing access to our prime brokers.
This means we can offer clients the very same service that we get from our prime brokers. We let clients choose their liquidity provider, with full visibility, and they can even speak directly to them and receive liquidity directly from them. We simply step in on the credit and settlement side.
Most other providers, who claim to offer this service, are simply selling their own aggregated liquidity, and if a client is offered massive leverage, posting very little margin relative to what the PoP provider posts with their prime broker, the risks are huge. This further compounds the risk issue in the markets.
What role do you think technology can play and are firms taking advantage of the different developments?
We have had a six-year programme of investing in, and developing, our own proprietary technology, and feel that this is the only way forward. It allows us to offer a differentiated service and put the necessary risk measurement in place.
This is why we have continued to invest when others have stopped. We have focused on providing our clients with the best possible journey, with a level of trading data that allows them to fully understand their risk as well as their trading opportunities.
What future challenges and opportunities do you foresee?
As I have said before, I believe that the challenges will be around risk and the need for FX brokerages to learn from the lessons of the market. There needs to be less risk and for companies to learn to regulate themselves. It is also essential that clients understand that very low pricing will almost certainly be linked to very high risk.
For us, the opportunity is around true PoP where a broker sits between the Prime Broker and the client, offering a true Prime of Prime service, not just a way of providing their own aggregated liquidity. We also believe that continued investment in technology, especially in risk systems, is essential.