Retail FX platforms braced for further consolidation

Banks and brokers in the retail foreign exchange market have experienced major changes over the past year as regulators have sought to clamp down on the market and platforms have begun to consolidate in response. In the latest move, the Federal Deposit Insurance Corporation (FDIC) announced a draft package of measures on May 10 that would impose stricter rules on how US banks deal with retail customers.

The rules, which aim to fulfil requirements laid out in section 742 of the Dodd-Frank Act, would require any bank engaged in retail FX transactions to collect customer margin in advance equal to 2% of the notional value of the transaction for major currency pairs and 5% for other currencies. Banks would also be required to improve the transparency of their recordkeeping and calculation of fees.

The FDIC rules are open to a 30-day comment period but if passed would have a significant effect on the US retail market. Citi, which is the major bank participant in that market with its CitiFX Pro platform, declined to comment on the rules but said it remains committed to the retail business and will expand to Italy, France, Germany and Cyprus later this year.

Regulations are not the only driver of change in the retail market. A need to increase transparency has emerged as a key market driver in recent months, with retail customers increasingly demanding financial disclosure from their providers, according to brokers. Gain Capital and FXCM both became publicly listed in December 2010. Drew Niv, chief executive of FXCM in New York, believes the advent of a public listing, quarterly earnings and annual reports has made the firm more attractive to retail investors.

"Retail customers are growing accustomed to transparent financials and demand it more and more; they are less forgiving of companies that do not put that information out there. When you trade with a retail FX firm that is not part of a bank, your money is not protected if that firm goes out of business," says Niv.

Niv expects increasing pressure both from clients and regulators is likely to drive other retail players to either go public or merge with publicly listed firms if they are not large enough themselves. The latest sign of consolidation was the announcement by Gain Capital on April 21 that it had bought Deutsche Bank's dbFX platform, which the German bank first launched in 2006.

Meanwhile, Danish investment bank Saxo Bank is a major provider of online retail FX trading outside the US. Although privately owned, Saxo believes it has competitive advantages over its publicly listed competitors that satisfy clients and regulators.

"The guy on the street with a retail FX banner offering currency trading through MetaTrader 4 doesn't have the same cross-product offering Saxo has. Plus, we operate with a bank guarantee – client deposits of up to €100,000 are guaranteed by the government. In terms of acquisitions, we always have our eyes open," says Kurt Vom Scheidt, chief operating officer and deputy head of foreign exchange trading at Saxo in Copenhagen.

New leverage rules in several countries have also caused a headache for retail participants. In August 2010, the US Commodity Futures Trading Commission (CFTC) cut leverage limits on retail trading accounts from 100:1 to 50:1. Japan's Financial Services Agency also cut leverage limits to 50:1 last year and will reduce them further to 25:1 in August – a move welcomed by some participants.

"In Japan, the leverage cap has lowered volumes but we think reduced leverage is good for the industry, as it helps reduce losses, especially for less experienced clients. At Citi, we never offered more than 50:1 leverage on CitiFX Pro," says Sanjay Madgavkar, head of FX margin trading and local markets at Citi in New York.

But leverage limits might be a further driver of consolidation among platforms. When the CFTC rules came into force in October 2010, Capital Market Services sold its retail FX business to Gain Capital in an effort to escape the rising tide of regulation. According to Gain Capital, it is only natural the clampdown will drive further consolidation.

"The regulatory environment has made it challenging for smaller providers to remain compliant when they have to spread effort and resources to maintain much higher levels of capital, reporting requirements and administrative staff," says Glenn Stevens, chief executive of Gain Capital in New Jersey.

The new rules will also affect non-US participants, as foreign brokers not registered with the National Futures Association (NFA) cannot accept US clients and a temporary CFTC exemption for foreign banks will expire in July this year. If consolidation of retail platforms does continue, it might also spell trouble for the NFA.

"I suspect the NFA will be hurt by the sharp decrease in membership fees because a lot of international business is moving offshore. We now pay huge amounts to the NFA – $2 per million traded – so are considering moving non-US clients offshore to London to decrease overheads," says Michael Stumm, chief executive at retail broker Oanda in New York.