If you had any doubts that the ESMA’s regulatory framework will change the retail forex industry as we know it, by now you know that the measures worked on multiple levels. Aside from becoming more risk-aware and having a longer lifetime, clients have lost significant buying power due to lower leverage.
The supranational EU regulator has managed to achieve its goal - to curtail the reach of regulated forex brokers to unsophisticated clients. That of course came at the cost of allowing into the market offshore firms, which are operating under a different framework.
Senior broker executives have shared in private conversations that they have been warning the regulators about these changes. To the credit of EU authorities, the crackdown came in a coordinated fashion, which made life difficult for offshore-only companies. Limiting deposits from VISA and MasterCard have been having a significant impact on deposits outside of the EU.
Nevertheless, as Finance Magnates reported to its readers back in December, millions of euros are still flocking offshore. Risk-hungry clients have found ways to satisfy their urges, despite the regulatory crackdown.
These have been the circumstances that have been well foreseen by some industry participants. The more interesting part, however, is how is the regulated market evolving at this time.
Industry Struggles
Over the past several quarters, volatility across currency markets has been less than optimal for trading. In fact, brokers have been consistently reporting abysmal numbers, especially since the start of 2019.
While some companies are weathering the regulatory storm just fine, other market players are starting to experience a hard time. Low volatility translated into low volumes, while the costs of running a book have remained constant.
The double whamming on trading volumes at major brokers translated into some sharp moves in the shares of publicly-traded brokers. CMC Markets, IG Group, and Plus500 all plunged over the past couple of quarters, but it was a move by GAIN Capital that sheds light onto what is going on in the market.
The company announced the launch of a rebranding strategy. The firm is leveraging its NYSE-listed name to launch a brand new category of products to the market. Under the GAIN Capital brand, the broker will be targeting professional and high-value clients.
Information put out by the company during its latest earnings call and our interview with Glenn Stevens, suggest that the broker is preparing to shake things up with an STP offering.
This move is not isolated, brokers who have been relying on booking client losses as gains have been subtly targeted by the new regulations. Running your own book is efficient as long as you can maintain a steady flow of volumes. These past couple of months have proven that maintaining such a flow is difficult at least in the current low volatility market environment.
STP Becoming the Standard
With the rise of regulatory worries about client profitability, brokers are starting to adopt new measures to deal with the issue. There is a clear consensus in the market that clients need to get better prepared before entering the marketplace. But let’s start from the broker itself.
True-STP execution is still a rare breed in the industry, and we are seeing many brokers redirecting trades to their own subsidiaries in other jurisdictions. While they do advertise to clients true ECN or STP execution, on many occasions that’s far from what they are offering.
The big advantage is now for brokers who are genuinely connected to multiple Liquidity providers and are delivering to their clients top of the line execution, providing a detailed trade breakdown on request. The battle for valuable clients is heating up, as those are the main generators of trading volumes by the admission of publicly-listed brokers themselves.
The expected review from the FCA on how do brokers reclassify retail to professional clients is likely only to reaffirm this trend. The UK regulator has mandated brokers to disclose a raft of data back in November last year, and if history is any guide, this step may only lead to action.
Market Makers Driven Offshore
Nowadays, if you want to spot a market maker, the most certain way is to look offshore. Brokers in foreign jurisdictions are looking for unsophisticated clients outside of the EU.
Brokers who run their own book offshore are not impressed with any execution stats, multiple Liquidity Providers and superior technology that can seamlessly deliver a state of the art user experience. What they continue to care about is attracting clients who can't trade.
Meanwhile, regulators, banks, card processors, and big tech companies are very unlikely to make life easier for the offshore side of the industry.
As the CEO of Saxo Markets UK, Andrew Edwards highlighted recently, "high leverage is irresponsible." The EU-regulated industry appears to have been steered into this realization by the ESMA.
Now, those market players that are prepared to make a transition will have a great competitive advantage. We have entered the era when attracting high-value clients is one step; the most crucial source of revenue in the long run, however, is retaining them.
