FXCM retail clients receive better prices for execution than institutional clients trading on the futures or interbank market, according to a study compiled by FXCM, the retail FX trading platform.
The study, which examined around 100 million trades going back a year on its own platform, as well as on three leading FX exchanges – the CME, Reuters and EBS – found FXCM was better than the equivalent quoted futures price on the CME 86.47% of the time. The prices were equal 4.36% of the time, while the CME offered better pricing 9.17% of the time.
In all, FXCM estimates the total savings to its clients are worth $36.35 million compared with what would have been available trading on the CME.
Similarly, in the interbank market, FXCM offered better pricing than the equivalent quoted interbank market 92.19% of the time, equal 3.12% of the time and inferior only 4.69% of the time. In this market, FXCM estimates a total saving to its clients worth $55.1 million.
While the findings look aggressive and the study is clearly self-serving, FXCM argues its methodology represents a conservative estimate of the price difference. The study compares its own actual fill order prices with time-stamp data provided by venues.
That means slippage is taken into account at the FXCM end, while it is assumed there was no slippage on the futures and interbank markets, despite the probability that slippage was higher in those venues given the larger orders.
The study shows the price discrepancy is highest in the less liquid pairs. This is because it is easier for market makers to exit a position in more liquid markets, allowing them to price more aggressively.
The difference in pricing of execution is explained largely by the absence of predatory traders on the retail platform, says Drew Niv, CEO at FXCM. “Our liquidity providers are only allowed to be price makers for our retail clients and not price takers.
“Only our retail clients can take a price which protects the market maker from potentially being picked off by larger or faster predatory market takers, making them more comfortable and giving them the ability to make a market based on quality of price and liquidity rather than speed.”
Free to trade
Ultimately, institutions are free to trade where they like, and they have the tools to analyse the pricing they are getting and how that compares across venues, says Brad Bailey, research director in the securities and investments group at Celent.
“There are a variety of providers that offer aggregated pricing or pure technology to create an appropriate means of comparing bids/offers from multiple counterparties," he says. "The key here for clients is to gain access to multiple counterparties, or access to multi-dealer platforms, where they can determine if they are getting competitive pricing.”
While none of the ECNs mentioned in the report was willing to comment on it specifically, responses did draw attention to the inherent difficulties comparing such different markets. They stressed they offer their customers a full-value proposition which includes the safety and soundness of clearing, transparency and liquidity in their markets.
|Drew Niv, FXCM|
Similarly, he acknowledges high-frequency market making is also an essential ingredient of modern markets, and is fundamentally just an evolution of an age-old activity. Being market takers on the larger electronic communication networks (ECNs) allows them to be more effective market makers for clients like FXCM.
However, the study does show that the regulatory push to promote on-exchange, central limit order book trading at the expense of over the counter (OTC) trading is misguided, says Niv, adding. “The market used to have an equilibrium, but regulators have changed that by pushing things onto exchanges.”
There is an assumption that the interbank market provides superior pricing. However, this is unclear because they do not publish data showing the prices at which trades for different clients were executed.
There is a view among some in the industry that banks and ECNs are feeling the pressure on issues such as price transparency and latency, and understand that their model invites HFTs that have an adverse influence on the trading experience of smaller clients.
However, they say, it is very difficult to change their model because some of the largest traders on those platforms thrive on that same opacity and their speed advantage. If they were to make the trading environment more democratic, they might jeopardize the liquidity that is their biggest attraction.
Niv says: “Exchanges were built for the big players and the high-frequency traders. The rules of access favour them and those with the most capital and the most speed dominate. Regulators believe exchanges are more democratic than OTC markets, but that is wrong.
"FX is done better when it is customized for the individual, which is what the OTC market offers. But this is not just an FX story – this is about OTC markets generally. One size does not fit all.”
Where traditionally only the most technologically savvy clients could effectively aggregate bids and offers and access multiple venue pricing in OTC FX, that capability is now more universally available, says Bailey. This should make trading OTC markets easier and more efficient than before.
Yet exchange-traded products do offer considerable flexibility for those that find they meet their liquidity and risk needs, adds Bailey. And it isn't only regulators discouraging OTC trading, he says: many smaller institutions, such as smaller quantitative hedge funds, have often found it difficult to find and retain the affordable prime brokerage relationships required to enable their OTC trading activities.
A fully audited version of the study has been sent to regulators, which FXCM hopes will encourage them to think again about its strategy of pushing all trading onto exchanges.
The study covers the period from October 1, 2014, to August 31, 2015. The comparison with each of the futures and interbank data is made at the time the FXCM retail client order was executed, and fees are excluded from the study. Both futures and interbank market data included only EUR/USD, GBP/USD, AUD/USD, NZD/USD, USD/CAD, USD/CHF and USD/JPY contracts.
FXCM was among the most high-profile casualties when the Swiss National Bank abandoned its exchange rate policy in January 2015, triggering volatility, the likes of which had not been seen for decades, with the broker being forced to take a $300 million loan from Leucadia National Corporation to cover losses and comply with capital rules.
To download the FXCM report, click here.