Hedge Fund Closures Can’t Slow Retail-Merger Flurry

Date: Friday, October 11, 2013
Author: Lucy Meakin, Bloomberg

FXCM Inc. (FXCM), the largest retail currency broker in the U.S., is leading a wave of buyouts and mergers in this corner of the $5.3 trillion-a-day foreign-exchange market as tougher regulation increases costs.

In the past month, New York-based FXCM bought a 50.1 percent stake in rival Faros Trading LLC and the American retail accounts of Alpari U.S. LLC. Gain Capital Holdings Inc. acquired Global Futures & Forex Ltd., Oanda Corp. bought Boston-based Currensee Global Inc., and Swissquote Group Holding SA (SQN) agreed to purchase competitor MIG Bank for an undisclosed price.

“In a world where regulation is very heavy, essentially scale is king,” Drew Niv, the chief executive officer of FXCM, said in a Sept. 30 phone interview from New York. “The guys with the biggest scale are going to win that race.”

A drop in currency volatility to levels close to before the financial crisis makes it more difficult for investors to make money. FX Concepts LLC, the firm founded by John Taylor whose $12 billion in assets in 2009 made it the world’s largest currency hedge fund, said this week it will shutter its investment-management business.

‘Bad Times’

At the same time, the 2010 Dodd Frank Act requiring firms that provide currency trading for U.S. retail customers to hold at least $20 million in capital, and changes to the European Union’s Markets in Financial Instruments Directive is also boosting costs for dealers, make mergers more appealing.

JPMorgan Chase & Co.’s Global FX Volatility Index fell to as low as 8.49 percent today, from as high as 12 percent in June. The gauge has been below its five-year average of 12.2 percent since the beginning of 2012, data compiled by Bloomberg show.

“Low volatility is the final nail in the coffin for a lot of people,” said Niv. “They’ll struggle through bad times in the hope that in volatile times they’ll make money anyway. But if they see extended periods of low volatility, it’s not worth being in the business without massive scale.”

Foreign-exchange trading for retail customers took off in the mid-1990s, with international banks offering products such as dbFX, which was operated by Deutsche Bank AG (DBK), the world’s largest currency trader. The wider availability of the Internet toward the end of the decade spawned a generation of smaller firms acting as middlemen with banks for retail clients.

Takeover Opportunities

“For a lot of smaller brokers, it becomes very expensive to do business, especially in the U.S. market,” Tim Smart, the chief financial officer of Oanda, which announced its buyout of Currensee Global last month, said in a Sept. 30 phone interview from Toronto. “The regulators are becoming very restrictive in terms of compliance matters. That provides an opportunity for players such as Oanda.”

Foreign-exchange returns trailed those of stocks last quarter by the most since the start of 2012.

Deutsche Bank’s Currency Returns Index, based on investment strategies including carry, momentum and valuation trades, rose 1.1 percent, compared with a gain of 7.7 percent for the MSCI World Index of stocks. That’s the biggest shortfall since an 11.6 percentage-point gap in the first quarter of 2012, data compiled by Bloomberg show.

FX Concepts

“FX as an asset-class business has been difficult this year,” Robert Savage, the chief strategist at FX Concepts, whose assets have shriveled to $661 million, said earlier this week. “Assets at the firm have dropped to levels that can no longer sustain the business,” according to an e-mailed statement yesterday.

With the Bank for International Settlements estimating that retail trading has grown to 3.5 percent of the foreign-exchange market, firms are concerned stricter regulation is on the way.

Such rules would largely be part of a broader response to the deepest financial crisis since the Great Depression, though they’re also a legacy of a series of failures among retail brokers that lost mom-and-pop clients millions of dollars.

WorldSpreads Group Plc, a U.K. brokerage and spread-betting firm, collapsed last year, resulting in losses that may be as much as 65 percent for customers, according to administrator KPMG LLP. The London-based company suspended trading in its shares in March 2012 because of “financial irregularities,” and later that month announced a shortfall in client funds of 13 million pounds ($21 million).

Quitting Retail

As well as Dodd Frank and the Markets in Financial Instruments Directive, or Mifid, brokers face the EU’s Capital Requirements Directives IV, which is due to be applied starting in January and increases liquidity and reserve requirements.

Currency traders are seeking an exemption from a proposed financial-transactions tax in 11 EU countries which they say would reduce liquidity and push up costs.

Alpari, whose U.S. arm was established in 2006, said Sept. 23 it’s withdrawing from retail foreign-exchange in America to focus solely on institutional trading. Chief Executive Officer Jermaine Harmon said the cost of complying with the reporting and capital requirements of U.S. regulators has made the retail side of the business untenable.

“The cost of actually doing business in this regulatory environment is very prohibitive,” Harmon said in a phone interview from New York on Oct. 8. “Unless you’re one of the larger players, like Gain or FXCM where you have operational efficiencies because you’re so large, it really doesn’t make sense to stay in this space.”

Trades Surge

FXCM estimates that almost 10 percent of its staff are devoted to compliance. It says it carried out an average of 411,498 retail customer trades a day in August, worth $14 billion, up 19 percent from the same period last year. FXCM closed at $19.76 on Aug. 29 and Sept. 27, the highest since its stock was offered in December 2010, data compiled by Bloomberg show.

Gain Capital (GCAP), which rebuffed a takeover bid from FXCM in April and went on to take over Global Futures & Forex last month, surged to a record $14.31 on Sept. 25, from $4.09 at the end of last year. The Bedminster, New Jersey-based firm says it had average daily over-the-counter retail trading of $5.6 billion and held customer assets of $485.9 million in August.

Brokers can also make money by allowing international banks -- whose mainstream currency trading units aren’t available to retail clients -- to use their infrastructure under the lender’s own branding. These white-label partnerships get their name from the vinyl records with blank labels that publishers distributed to anonymously test listeners’ responses.

Barclays Plc (BARC) used an FXCM platform to create Barclays Margin FX last year. Clients to this service on average deposit three times what an FXCM customer will put in their account, Paul Inkster, the head of product at Barclays Stockbrokers in London, said in March. HSBC Holdings Plc (HSBA) based its Margin FX offering in Hong Kong on an Oanda product.

“It’s something that, for a certain segment of clients, is very sought after,” James Carter, the head of retail foreign-exchange business development at HSBC, said in a phone interview from Hong Kong. “It’s a very large part of the FX spot volume every day. There’s a lot of incremental volume from this business.”