ABN Amro and Deutsche Bank look to have set a precedent with their moves into the retail foreign exchange market in 2006. Both did so in partnership with established retail FX platform providers. Market sources are now predicting that at least three top 20 FX banks will sign partnerships in the first half of 2007 to join them, with others following shortly after.Gain Capital, CMC Markets, Saxo Bank and Oanda, which has already partnered with ABN Amro, all confirmed to Euromoney that they have had discussions with banks over the past few months: "Until last year none of the banks had dipped its toe in this market. Now that a few have taken the plunge, we are having many more discussions with large sell-side banks," says Mark Galant, chief executive of Gain. In a similar vein, Peter Cruddas, chairman and chief executive of CMC, admits talks have been held but says: "We have not signed with anybody yet." ClientKnowledge, a research and advisory firm, states in a soon to be published report called Retail FX: Understand the trend, leveraging the opportunity: "There is a fundamental business rationale driving interest in this sector." The company says it is not uncommon for the large retail platforms, such as Saxobank, to attract daily turnover of about $15 billion and it believes there are already up to 100 platforms. This might be a conservative estimate.
The micro-structure of the retail sector is similar to the interbank market in that the lions share of turnover goes to the top 10 platforms. According to ClientKnowledge, about $50 billion a day is now generated in the retail segment about 2% of the markets total turnover. At first glance, this figure appears much lower than the oft-cited claim that the retail segment accounts for up to 15% of activity in FX. However, the vast majority of this is undoubtedly spot business. So it seems that the retail segment probably accounts for about 5% of the overall spot volumes.
Perhaps more important, the business is seen as extremely profitable. Justyn Trenner, ClientKnowledges principal and chief executive, estimates that annual revenues from the retail FX sector could be as high as $2 billion. And he adds that with strong double-digit growth rates, it is still rapidly expanding. Richard Olsen, Oandas joint chief executive, agrees that growth rates will remain high. "The idea of internet trading has still not reached the man on the street. The potential for further client growth is huge."
Galant agrees. Forex.com, the retail platform that Gain established in 2001, now has more than 50,000 clients and reported 90% growth in 2006. "The large sell-side institutions see the growth and the amount of volume that the non-bank firms like ours are achieving and so are, understandably, starting to seriously consider entering the space," he says.But the big banks have to consider carefully how to enter the retail market. Wholesale institutions will almost always struggle to deliver the level of client care that retail FX demands. So in their absence, entrepreneurial retail platforms have established the infrastructure, client services and technology to mop up the demand. It is likely to prove hard for banks to succeed in the sector if they try to go it alone. So they have to consider other options. Acquisition of an existing platform is one that might materialize in time; the other is partnership, which is likely to prove more appealing. "White-labelling an established platform is perceived as the quickest, most secure and most effective way for these large institutions to enter the retail space," says Trenner.
Many of the retail platforms already have experience of white-labelling, but previously they have gone down or across, rather than up. The white labels can have different forms. "Everyone is different. At Gain partnerships range from us providing everything, from the call centres to the technology and the partner just using their name, through to Gain just being involved in one part of the infrastructure puzzle. Its all about distribution, and obviously these types of partnership platforms allow us to tap into a much larger client pool," says Galant.
Despite the attractions, so far very few banks have taken the plunge. Privately, many insist they will not bother. "If your grandmother blows her pension punting FX on a retail platform, its not a big story. If she does it on one with our name on it, it will be front page news," says the global head of FX at a major player.
Galant appreciates this view. "Reputational risk will leave some banks watching from the side lines. Certain early movers have taught others that thorough due diligence and a careful choice of partner is essential and I think this change in mind-set has caused the recent slowdown in momentum," he says. Few would disagree that working with a retail partner carries risk, as some definitely have the bucket shop label associated with them.
As Trenner says: "The very nature of retail FX means that clients are taking punts and losing money. Retail FX is not associated with the same high regulation standards that the rest of the banking sector must comply to and so the slightest tarnish to a name could be very detrimental."
The retail players themselves might not necessarily rush into deals as soon as the big banks come knocking. They need to consider what is in it for them. "For the smaller retail players, they must make sure that they gain as much leverage by working with the larger players to really justify the defocus from their own named business," says Lars Christensen, chief executive of Saxobank. Olsen outlines another problem: "These big banks have very large captive audiences that are willing to pay quite wide spreads in the traditional FX business. The banks dont want to undercut the spreads on their existing platform by establishing a tight trading retail platform."
Some banks might decide that the best option is to capture the flow at second hand by providing liquidity to the more reputable companies. That way, they see some of the benefits without the possible risk to reputation that being the front-end provider brinks. As Saxos Christensen concludes: "I think there are going to be more complications for the big banks moving into this space then has been generally assumed."