Mark Galant CEO, GAIN Capital Group
Mark Galant CEO, GAIN Capital Group

Retail meets Wholesale FX: A growing convergence

With both sides of the market converging, Mark Galant looks at how all FX clients will gain equal access to superior service and technology.

First Published: e-Forex Magazine 17 / e-FX Industry Report / January, 2005

Until the mid 1990s, the disparity between wholesale and retail forex trading was clear. Banks and institutional clients enjoyed exclusive access to forex while the retail market, simply put, did not exist. Fast forward a decade and wholesale and retail are rapidly converging, actively collaborating and, in some ways, competing. Each side, while unique, shares similar objectives (e.g., employ advanced technology, expand product lines, grow revenue) which are helping to bridge the gap between wholesale and retail.

Although the banking industry continues to cater to large corporations and hedge funds, it has not disregarded the impact of retail trading and its growing popularity. Actually, in recent years, many leading FX banks have shown a greater interest in the retail space, attracted by the significant trade volume they can receive from retail dealers who act as a conduit for their thousands of retail customers.

Meanwhile, retail dealers have matured rapidly in the past decade. Out of the pool of start-up, tech-savvy dealers has emerged an elite group of well-respected companies led by industry veterans and equipped with the sophisticated technology and expertise to serve the retail and smaller institutional market segments.

Changing Marketplace
All emerging trends are fueled by consumer interest and retail forex is no exception. The dot-com bust of 2000 left in its wake many disillusioned investors eager to explore alternative asset classes. Already comfortable with online trading, investors were soon lured by the FX market’s 24-hour accessibility and commission-free trading, as well as the increased regulatory oversight of government agencies such as the CFTC and NFA in the US and the UK’s FSA.

Not wanting to compete directly with the banks, retail dealers focused their services on a wholly different (and, at the time, underserved) customer segment - smaller hedge funds and money managers, as well as self-directed individuals. To appeal to these individuals, successful retail dealers were quick to distinguish themselves from each other as well as their wholesale counterparts on two fronts – service and technology.

Service

From a basic service perspective, both bank and non-bank dealers perform similar functions: provide 24-hour liquidity, offer pricing and execution services, and act as a counterparty to customer transactions. But, taking a cue from the online equity brokers, retail forex dealers set out to make the FX market more efficient and cost-effective.

Two significant service improvements introduced by retail dealers are 1) lower margin requirements via leverage up to 100:1 or more, and 2) lower transaction costs through commission-free trading at very competitive dealing spreads.

One-stop shopping is another benefit for retail customers. The non-bank dealers play the roles of credit intermediary, liquidity aggregator, market marker, clearing firm, and technology provider. In many ways, retail dealers perform these functions more efficiently than their banking counterparts.

The credit process, for example, can take months to complete at a bank. At GAIN Capital, money manager clients can start trading in a matter of days, despite the rigorous “Know Your Customer” (KYC) screening process required on new accounts.

For money manager clients, top retail firms developed proprietary back office solutions which provide valuable administrative and operational support. From handling all application processing and account set up to delivering real-time account reporting to both the money manager and their clients, retail dealers supply products and services integral to the money manager’s operation. These and other types of innovations spurred the interest of professional money managers so while the hedge fund industry as a whole has mushroomed over the last several years, FX is increasingly traded as an asset class in its own right.

Large financial institutions lack both the technological capabilities and the infrastructure to effectively and cost-efficiently target all but the largest customers. With a low cost infrastructure and a unique focus on the needs of small- to mid-sized funds and money managers, retail firms are well positioned to service this rapidly growing customer segment.

Technology
When online FX trading was first introduced to the buy side in the late 1990s, initial client uptake was slow. Indeed, first generation bank platforms offered little improvement in price discovery, execution, or STP. But retail dealers were quick to recognize how sophisticated technologies could attract new clients and that’s when the market began to see real possibilities.

One early innovation introduced by retail platforms was improved price transparency. GAIN Capital’s introduction of “executable streaming quotes” in May 2000 created full transparency in FX pricing and eliminated bank’s exclusive disclosure rights to price quotes.

As a result, smaller forex traders today can not only participate in FX trading, but they also stand on equal footing with large institutional customers. Since 2000, this pricing mechanism has become the de facto standard; many independent and bank-owned systems have incorporated this pricing method due to competitive pressures and strong client demand.

Other advanced features offered by retail dealers and not available on traditional bank platforms are real-time account information, robust position management tools, complex order types such as If/Then, OCO’s, Trailing Stops, etc., and advanced decision support tools. Through advancements in technology, retail dealers have implemented automated order execution and electronic order flow processes, resulting in a fast and cost-effective approach to processing high volumes of low-value orders. In fact, retail dealers, above all others, excel at handling exceptionally large volumes.

Technology has also enabled retail dealers to offer clients execution services that are not widely available to typical bank customers. At GAIN, for example, customer market orders are typically executed in less than one second, including a pre-deal margin check. Extensive dealer-side technology allows GAIN’s traders to manage customer transactions, view position risk in real-time, efficiently monitor and execute pending customer orders, and electronically hedge with bank liquidity providers.

Looking ahead
Ironically, today’s least sophisticated clients have access to the most advanced technology while professional bank clients are still coping with traditional tools. But, as both sides of the market converge, all forex clients will gain equal access to superior service and technology.

Already, we’ve started to see early signs of growing convergence. On the client side, for example, some bank clients are migrating to non-bank dealers to benefit from faster execution and the individualized attention not available at a large bank environment. On the dealer side, leading banks are exploring strategic acquisitions to tap into the retail market’s advanced technologies and gain access to a new, lucrative client base. Also, more and more banks are offering electronic liquidity to retail dealers to ensure that volume flows back to their desks. But, ultimately, it’s the banks with the best technology that will reap the lion’s share of retail volume.

Going forward, we expect strong client demand for advanced tools and improved client service to drive further convergence between retail and wholesale as both bank and non-bank dealers hasten to meet the changing needs of the marketplace.

About GAIN Capital Group
GAIN Capital Group is a leading independent provider of foreign exchange services, including direct-access trading and asset management. The company’s flagship service, GAIN Capital (www.gaincapital.com) focuses on the needs of professional forex traders and money managers. FOREX.com (www.forex.com), GAIN’s retail division, provides individual investors with advanced trading tools, lower account minimums and extensive educational content.