Further consolidation looms in retail FX

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Volumes in the retail foreign exchange market are booming, and the market is changing fast. According to estimates in a recent report by Boston-based research firm Aite Group, retail FX now accounts for roughly 6% of overall FX market volumes and 18% of the spot market, with $280 billion traded daily.

The past six months have also seen a flurry of structural change, as regulators continue to clamp down on the retail market and major firms look for inorganic growth opportunities. After FXCM failed in its proposed takeover of Gain Capital in April – a deal valued at $210.4 million that would have brought together two market leaders in retail FX – Gain Capital agreed to buy GFT for roughly $107.8 million.

"Some of the merger and acquisition activity we've seen is a result of pent-up demand in the past 18 months," says Glenn Stevens, chief executive of Gain Capital in New York. "Last year was challenging in terms of market conditions, higher regulatory hurdles, reporting requirements and uncertainty in the market. Many in FX – whether banks, institutional platforms or retail shops – were close to their margins and were suffering. Some had investors losing patience. You cannot deny the benefits of scale in this kind of business."

The question, then, is which firms are best placed to scale up together – and the turbulent nature of the courtship between FXCM and Gain in April shows there is little certainty there. Retail brokers expect the number of providers to shrink, particularly in the US, where participants are feeling the strain from strict regulations imposed by the Commodity Futures Trading Commission in 2010.

Most problematic, say brokers, is a US restriction limiting their leverage to 50:1 for major currencies, which is substantially harsher than in other countries and has prompted many clients to move offshore. This, combined with an increase in capital requirements, has led to some brokers shutting down parts of their businesses. GFT ceased operations in the US and Japan in December 2012, while FX Solutions terminated its retail FX business as of March 1, transferring custody and clearing of active accounts to Gain Capital.

"We have had enormous regulatory changes in the past seven years. If you look at 2005 to 2013 in the US, retail FX went from being the lightest regulated to the heaviest regulated retail financial market. It has the most expensive licence; it has the highest standards; and we think execution is one of the things that is likely to be heavily regulated as well," says Drew Niv, chief executive of FXCM in New York.

But retail FX has attracted investors for years, and the enduring popularity of the market at a time of rapidly accelerating regulatory oversight has caused problems for providers.

"Lower barriers to entry are essentially pushing margins and spreads down. More players in the market means there is lower profitability across the industry and it is more expensive to acquire new clients. Another challenge is the fact that the number of clients in the retail FX market is stagnating, and that creates conditions for more consolidation in the industry," says Didier Abbato, head of global product management at Saxo Bank in Copenhagen.

"Clients have a massive amount of choice," adds Paul Hayward, head of sales at Oanda in London. "When they come to you they are usually pretty well-informed of the offerings out there. Clients are becoming interested in FX as an asset class and they are demanding high standards. They want to be able to trade on the go with their mobile and they want to access educational tools."

But despite the challenges, retail FX continues to see new entrants. Aite Group expects the retail market to grow at more than double the rate of the broader FX market in the coming years as online trading continues to gain favour and the barriers to entry fall. US-based Interactive Brokers introduced FX trading in 2005 and has seen steady growth since then – but the firm attributes its success to being a multi-asset-class broker rather than focusing purely on FX.

"Not only can you trade forex as a standalone product but if you are trading options or securities or any other asset class and you need to trade forex in conjunction with that – for instance you deposit pounds and want to trade US stocks in Germany – then we make it easy for you," says Steve Sanders, executive vice-president for marketing and product development at Interactive Brokers in New York.

Many expect the recent flurry of consolidation in the retail market will continue and, despite the failure of its efforts to buy Gain Capital, FXCM's Niv is bullish about his firm's ability to grow. "You should expect us to buy someone in the future and you should expect more mergers in the market. We are in constant talks with lots of different people and we just raised $173 million in convertible bonds – so we've got a lot of ammunition to go out there and buy," he says.

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