Single Dealer Platforms – marking the end of uncoordinated e-trading delivery channels

It is somewhat against expectation that the value proposition of single dealer platforms (SDPs) in the FX market continues to strengthen and as Nicholas Pratt reports, they are now considered the prime relationship channel for increasing numbers of FX providers.

 

Since electronic trading in FX began to be adopted at the turn of the millennium, there has been a continuous battle for buy-side business between the multibank portals offering access to numerous liquidity providers from a single source and the SDPs offering numerous services form a single provider. 

There have been highs and lows for both sides of this competition but neither has struck a decisive blow and, no matter how counter intuitive it may seem, both multibank portals and SDPs continue to develop apace. Both sides may claim to be of more value to buy-side customers than the other and this may be hard to prove. The value proposition of an SDP for the banks is easy to argue – there is a single and coherent point of contact that enables the banks to maintain their relationships with their customers rather than being one of many on a multibank portal or electronic communications network (ECN). But does this compelling sell-side advantage also work for buy-side firms and, if so, does it manifest in a greater number of FX trades being enacted via the SDP channel rather than through multibank offerings?

 

Single Dealer Platforms –  marking the end of uncoordinated e-trading delivery channels

New offerings

What is clear is that the providers in both the multibank/ECN and the SDP space feel that there is enough interest in the market to warrant the development of new offerings. Already in 2012 we have seen eight new ECNs launched and a merger between two of the largest incumbents at a cost of $625 million. And on the SDP side, banks continue to either launch new offerings or revamp existing ones. Furthermore, the banks involved are not just limited to the top tier, global investment banks or broker/dealers that have dominated the interbank FX market for so long but also include strong regional banks with a corporate client base. 

In the first half of 2012 Citi has released Velocity FX while Deutsche Bank has released a new version of its Autobahn platform. Meanwhile Commerzbank has developed the Commander platform based on the foundations of its Click & Trade FX platform and BNP Paribas has released Cortex, replacing the old FX eTrader platform it developed some years previously.

Aside from the competitive challenge from both the multibank world and from within their own field, SDPs have also faced the challenge of adapting to new, post-crisis regulations, notably the move towards central clearing and away from bilateral trading. The anticipated emergence of new central clearing venues and swap execution facilities (SEFs) was expected to diminish the value of SDPs. Instead though, banks have realised that their SDPs represent a way to deal with a new fragmented marketplace should the FX world go the same way as the equities world following a regulatory shake-up – provided they can develop their offerings in the necessary way.

The principle theme behind this second wave of SDP development is a greater focus on customer services and to offer a greater range of services than simply liquidity provision. It is not so much the battle for real estate on a trader’s screen but the challenge of facilitating improved standards of service, enhancing the user experience and adding value across the whole trade lifecycle. This means the addition of pre and post trade services including research, risk management, transaction costs analysis (TCA) and post-trade reporting. There is also a greater focus on multi-asset class trade execution, especially from the regional banks that recognise their buy-side clients are increasingly adopting a multi-asset class approach to their trading and are looking for their banks to adopt a complementary approach in developing their SDPs. 

Challenges

After an uncertain start 10 years ago, SDPs have become a critical tool for FX dealing banks. Every tier one bank has one and most tier two banks now have one too. It is an essential channel, says Paul Caplin, founder and chief executive of Caplin Systems, a provider of web trading technology for the banking industry. He says that, “FX has gone electronic relatively recently (in the last ten years). The first challenge was to manage the risk of pricing electronically rather than the slow and expensive manual method. Electronic pricing is much more scalable, error-free and faster so it was always likely to dominate once liquidity aggregation and order management could be made reliable.”

The next challenge was how to communicate with clients. “Once FX went electronic banks first sent their clients to the multi-dealer platforms. Firms such as FXall achieved early success and banks assumed that clients wanted to see multiple quotes before they traded, so why not send them to the sites that were already set up, especially as the major FX banks had their prices listed on these platforms and even had equity stakes in some of them.” 

However, the premise that all customers wanted multiple quotes turned out not to be true. “A lot of buy-side firms don’t need multiple quotes before they trade. They will look at various quotes from other sources but are often happy to trade on SDPs and the majority of flow goes that way. So it has become a high priority for banks to develop their SDPs because it is a huge advantage for them to have a one-to-one electronic relationship that mimics the voice trading relationship.” adds Caplin.

The main challenge then became how to build these SDPs effectively, how to make it work on multiple desktops around the world, how to support a large number of users all with different environments and how to make the platform compelling enough for  clients to use. “Essentially it is a challenge of imagination and UX-design skill,” says Caplin.

Paul Caplin “...it has become a high priority for banks to 
develop their SDPs because it is a huge advantage for them to have a one-to-one electronic relationship that mimics the voice trading relationship.”

Paul Caplin

“...it has become a high priority for banks to develop their SDPs because it is a huge advantage for them to have a one-to-one electronic relationship that mimics the voice trading relationship.”

The catalysts

In the early days of SDPs, it was only global tier one banks that had the technical and financial resources to build them. Over the last five years, the difficulty of building a web-based SDP has plummeted. It is now something you can create much more easily thanks to a number of software providers, such as Caplin and others. The tipping point came about three years ago when almost every bank started to talk about building one. Since then, although the technical challenges remain largely the same, there has been one key technology development, says Caplin. 

“HTML 5 has revolutionised the market. Three to five years ago it became very clear to medium-sized and large banks that they have to build an SDP but there was this uncertainty about the best technology to use. Java, Silverlight, Flex were all about delivering content via the web but banks were holding back on their investment in their SDPs because it was not clear which technology would succeed in the long term. But now it is universally agreed that HTML 5 is the de facto choice. It has come of age. So banks can breathe a sigh of relief.”

In addition to technology development, the other major influence in electronic trading has been regulation. Despite a great deal of talk from banking supervisors regarding central clearing and best execution, the specific content of regulation is still unclear in both the US and the EU. The clearest conclusion that can be drawn so far is that FX is the least affected of all asset classes. It was explicitly excluded from Dodd Frank and there is no indication that that decision will be reversed, although FX Options are expected to be included. In the EU, MiFID II is very uncertain. There are Draconian statements coming from Brussels but there is a general expectation that these will be watered down before implementation. 

Joe Cassidy “We don’t see ourselves as a dealer but as a 
provider of multi-trade services to our corporate clients – essentially we are helping clients to manage their portfolios in a broader sense.”

Joe Cassidy

“We don’t see ourselves as a dealer but as a provider of multi-trade services to our corporate clients – essentially we are helping clients to manage their portfolios in a broader sense.”

In addition to technology development, the other major influence in electronic trading has been regulation. Despite a great deal of talk from banking supervisors regarding central clearing and best execution, the specific content of regulation is still unclear in both the US and the EU. The clearest conclusion that can be drawn so far is that FX is the least affected of all asset classes. It was explicitly excluded from Dodd Frank and there is no indication that that decision will be reversed, although FX Options are expected to be included. In the EU, MiFID II is very uncertain. There are Draconian statements coming from Brussels but there is a general expectation that these will be watered down before implementation. 

In derivatives-heavy markets like fixed income, it was initially feared that the regulations around central clearing and execution might actually spell the end of single dealer platforms as a viable channel. But in fixed income, banks are actually increasing their investment in SDPs, says Caplin. “Banks need customers. In the OTC markets, they have been making the markets themselves as dealers but now they have to provide access as brokers. The regulation won’t simplify the market, it will make it more complex – as we have seen in equities. There are likely to be more execution venues in Europe and SEFs in the US, it will be a more complicated liquidity landscape and a major headache for buy-side firms. There will be a lot of scope for smart order routing and sophisticated margin management.”

He also adds that “Banks have realised that they will make less money from execution but more money from post and pre-trade services, such as liquidity aggregation. So having a compelling e-channel to offer their clients is even more important for banks. If you are going to become a swaps execution facility (SEF) broker or a liquidity aggregating broker, you’ll need to keep your customers.” 

Not all swaps will be centrally cleared so banks will have to provide an integrated picture of the market, dark and light liquidity, on and off exchange, centrally and bilaterally cleared, similar to what has taken place in equities. 

Will the same thing happen in FX? “People aren’t worrying about it too much at the moment,” says Caplin “There is so much benefit to bilateral trading and the platforms are becoming so easy to build that they are still a compelling option. For the last two to three years we have been helping regional giants, like Standard Bank and Unicredit, to bring out FX SDPs. But we’re now seeing a huge demand from the slightly smaller regional banks. I don’t see regulation holding them back because I think FX will remain an interdealer market, at least in terms of vanilla FX.”

But, says Caplin, there is a Holy Grail for SDPs – for banks to have a single platform that also has best execution data showing that clients have the best prices alongside other anonymous prices, effectively doing the paperwork automatically for the buy-side managers. Will all banks be able to attain this Holy Grail or will some fall short? What holds the key to developing a successful SDP? “Some banks will get it right and some will get it wrong,” says Caplin. “It’s all about workflow and making customers’ lives as easy as possible by supporting their needs directly. Some are stumbling because they haven’t thought it through, like a bookshop working out how to sell books online.”

Multi-trade services

As the banks grapple with the challenge of creating a compelling SDP, it is noticeable that a more customer-centric approach is being championed by the regional banks with a more commercial and corporate client-base as opposed to the investment banks that launched the first wave of SDPs. And a key feature of this approach is to make the platform a multi-trade service and multi-asset class proposition. 

“Historically the investment banks used the single dealer platforms (SDPs) to engage with their clients in a particular asset class where they had a certain depth of liquidity and differentiation. We see our platform developing in a different way,” says Joe Cassidy, head of electronic commerce and OTC derivatives clearing at Lloyds Bank Wholesale Banking and Markets and formerly head of prime brokerage and OTC clearing at Deutsche Bank. “We don’t see ourselves as a dealer but as a provider of multi-trade services to our corporate clients – essentially we are helping clients to manage their portfolios in a broader sense.”

“Some of these services we will develop and provide in-house, and others will be provided by third party partners which we will aggregate. We see the regulatory pressure in the market creating a more regionally-based approach to many services, so we will look to partner with other regional banks for asset, risk and liability management needs that we are not best placed to provide,” says Cassidy. 

For the more trading-focused investment banks, regulatory pressure around best execution will become a big issue and consequently their trading platforms will focus more on smart order routing and liquidity provision / aggregation over time. For Lloyds Bank, the trading platform is a different proposition, says Cassidy. “We’re not looking to create a mini version of their trading platforms. There will be some overlap and some competition in certain areas but we are primarily service-based rather than product-based and we are focused on multiple asset classes rather than being asset-class specific.” 

Thomas Soede“One of the main drivers for the increased popularity and production of SDPs is the fact that they produce a much more agile development environment for the banks when compared to the multi-bank platforms,”

Thomas Soede

“One of the main drivers for the increased popularity and production of SDPs is the fact that they produce a much more agile development environment for the banks when compared to the multi-bank platforms,”

 

Traditionally many other single dealer platforms have been limited to single asset classes so it has been harder for clients to get a full view of their portfolios or their collateral or cash balances. “We feel as more clients look to optimise their portfolios, they are not looking at specific asset classes. So our aspiration is to build that portfolio position for our clients..”

The product-centric strategies that investment banks are targeting will continue, says Cassidy, but increasingly the focus will be on strategies rather than asset classes. “Regulation will influence how these strategies will be expressed and how long they will be viable, especially if central clearing replaces bilateral trading and all Swaps are collateralised. For example, if I have a short-term hedging strategy, I may utilise a “hybrid” listed product that replicates a swap without incurring the cost and collateral obligations of a swap, or even revert to using Cash products. That is our aim – to give our customers the ability to compare these costs before making a strategic decision.”

Some of the investment banks may be strong on providing pre and post trade services for particular asset classes but weaker in providing them on a multi-asset class basis, says Cassidy. This is beginning to change but perhaps not fast enough. There may have been some regulatory slippage of late that has held back the adoption of central clearing, slowed down the anticipated changes to the market as well as removing some of the impetus for the investment banks to reposition themselves and their single dealer platforms on a more multi-asset footing. 

 

Rebuilding trust 

Yet, says Cassidy, it is undeniable that there is a strong wind of regulatory change blowing through the capital markets. “Rebuilding trust is a big part of this change. And there will be competition from new entrants and new venues, such as the one developed by money manager BlackRock for the fixed income market that will allow it to trade directly without having to go through the major banks or broker/dealers.”

In addition to providing a multi-asset class capability, Arena - Lloyds Bank’s platform is also looking to provide support via multiple channels. “We are not just targeting the desktop but also looking to make the platform accessible on a tablet or a mobile. It is about revisiting the customer’s journey throughout the day. We are not just a trading platform but a decision support tool and a window on the portfolio. Increasingly corporate clients have multiple holdings operating in multiple jurisdictions and they want information there and then. So we want a seamless link between multiple channels, whether it be the desktop or a mobile.” 

As well as joining up the various channels and asset classes within Lloyds Bank, Arena is also looking to combine this aggregated view with the data provided by other banks used by their clients. “Banks are not always joined up internally, let alone with other banks and that burden of providing an aggregated view often falls on the clients themselves. Our value proposition is to take some of that burden away, intercept the SWIFT messages they receive from multiple banking partners and give them an aggregated view of all their activity.”

It is a different approach to that taken by the investment banks that have dominated the FX markets for so many years and where the purpose of the single dealer platforms was to target as much of the traders’ screens as possible. “We’re looking to find a way to be compelling to customers based around trust, transparency and customer service – and that means taking a portfolio view.”

BNP Paribas is a bank with a strong regional heritage that has recognised the virtue of using the SDP channel to provide a full range of services beyond simply execution, something that is far harder for the multibank portals and ECNs to provide. “One of the main drivers for the increased popularity and production of SDPs is the fact that they produce a much more agile development environment for the banks when compared to the multi-bank platforms,” says Thomas Soede, Global Head of Electronic Markets at BNP Paribas, which unveiled its new single dealer platform Cortex earlier this year. “The SDPs are not just venues where the banks can send their prices. The software is designed in-house and the services can cover more than simply the functional enhancement of execution. It is about providing support and services from pre-trade to post-trade. So the agile development environment allied to the front-to-back service means that we are able to listen to and respond to clients’ demands in a much more complete way,” he adds.

Client-centric approach

As already mentioned there is an increasing focus on support for multi-product and multi-asset  classes being taken by the single dealer platform providers, in contrast to the multibank offerings that are typically single asset class-based. Technology can also now be leveraged to permit an application-based approach, enabling users to drag and drop and consume apps that they need to complete their client journey, says Soede. “Our approach is based on the notion that SDPs should be customised to suit clients rather than forcing clients to change to suit the platform. It is about putting our clients in the driving seat. We view Cortex as a control centre for our diverse range of clients.”

Such a client-centric approach also enables banks to assume a more collaborative relationship with their clients by, for example, sending notifications based on specific transactions, such as the maturity of an option rather than mailing generic research notices that typically end up in the junk folder of clients’ email accounts. “It is a collaboration tool where clients get trade and market specific notification, such as the maturity on an option or a forwards contract,” says Soede.

Soede recognises that this does mark the beginning of a split between the traditional investment-bank/broker-dealer based platforms that are largely based on liquidity provision and execution. This split will be especially evident in the impact of anticipated regulatory change, particularly the emergence of swap execution facilities (SEFs). 

He says, “Corporates will be more or less unaffected by SEFs but there are other clients such as large hedge funds or real money managers that will be affected and this will have an impact on the kind of products that we make available on the platform. It will require us to think more creatively and to offer SEF-like execution through the use of smart algorithms.”

 

Single Dealer Platforms –  marking the end of uncoordinated e-trading delivery channels

 

BNP Paribas plans to offer direct market access to the SEFs and then provide service layers between the BNP Paribas platform and the SEF, populated by smart execution algorithms that will aim to outperform market benchmarks. Given that uncertainty still prevails as to how the SEFs will operate and what the minimum thresholds will be for regulated instruments, there will be some improvisation needed to navigate the upcoming period – similar to the changes in market structure and fragmentation that has occurred in the equities market. “What we do know is that we want to differentiate ourselves through the strengthening of our APIs and the quality of our algorithms. And as the bank has a strong quantitative background, we feel we are well positioned to do that,” says Soede.

As well as the impact of regulation, the other big influence on the development of SDPs has been technology. Aside from HTML 5.0 and its benefits on the UX side, there is also architecture that allows large applications to communicate and interact with each other. There are two approaches says Soede. “The first is to provide 150 apps and tell clients they are free to use whichever ones they want. But as the apps become more complex, the choice also becomes more complex and there is the potential to create some confusion for clients. We are developing our apps, but we are organising them to cater to different client segments so it makes it easier for them to select the right ones. We engage with the client and propose a journey to them from pre trade, trade to post trade rather than impose a factory of apps on the client.”

 

 

Tipping point

Soede feels that a tipping point been reached where every bank now has a SDP of some sort, whether it is a white labelled, grey labelled or in-house developed platform. “The important point though is that there is a relatively small number of banks left that have the skill, the experience, the expertise, the distribution and the investment appetite to continue to enhance the platform.”

He goes on, “So I think that those banks with a marginal return on their investment in SDPs will see an increasing amount of their business go to competitors that will be able to offer clients smarter, faster and more cost-effective ways to access the market and more powerful pre, trade and post trade services. The banks that have found it more challenging can instead opt for a vendor relationship in developing their SDP but they will find that they do not have the agile development environment they need to react to clients’ demands. A vendor relationship can get you to market quickly but after that, it can be a painful experience.”

Another bank pursuing a client focused strategy in the deployment of its SDP is Canadian based CIBC. “Good banking relationships are built over time, and it is important to create solutions that help clients execute their business strategies in a timely and cost effective manner,” says Takis Spiropoulos, Managing Director and head of e-commerce solutions group at CIBC World Markets. “Listening to clients and understanding their needs is key to strengthening and deepening the relationship.  An SDP that addresses those needs and has value-added functionality that goes beyond price discovery and trade booking is a differentiating tool in a bank’s arsenal.”

These value-added services are going beyond the traditional execution services offered by an SDP reflecting the growing sophistication of the users. As Spiropoulos says, streaming executable rates and display of market depth in the pricing panel are useful information in timing trade execution, but so is intraday market colour and timely delivery of research and trade ideas as well as the provision of algorithmic trading tools. “Sophisticated clients can use CIBC’s platform to minimise market impact by employing algorithmic execution capabilities such as time-slice and iceberg orders, and auto-hedge the FX exposure of inter-listed equity flows using FIX API capabilities.”

The use of execution algorithms has been steadily increasing over the last couple of years, and more banks will clearly be incorporating that functionality in their SDPs in the future.  It is interesting that recently, this type of bank owned intellectual capital in execution algorithms has also been exported from the realm of SDPs to become available over some multi-dealer platforms.

Takis Spiropoulos “Listening to clients and understanding their needs is key to strengthening and deepening the relationship.  An SDP that addresses those needs and has value-added functionality that goes beyond price discovery and trade booking is a differentiating tool in a bank’s arsenal.”

Takis Spiropoulos

“Listening to clients and understanding their needs is key to strengthening and deepening the relationship. An SDP that addresses those needs and has value-added functionality that goes beyond price discovery and trade booking is a differentiating tool in a bank’s arsenal.”

 

Customisation

As well as increasing the breadth of services and tools available on the SDPs, the other main development, says Spiropoulos, has been catering for greater customisation, especially as the phrase ‘client experience’ is increasingly commonplace in the strategies of the SDP providers. “An institutional client who uses an e-commerce platform to trade frequently intra-day has very different needs to a mid-market or large corporate client that trades occasionally to hedge present and future cash flows.  This is where customised workflows, post-trade analysis and reporting can make a material difference in the client’s experience.”

For example, says Spiropoulos, depending on the size of the corporation and its internal policies, the segregation of duties between authorizing the execution of a transaction, carrying out the transaction, and choosing the appropriate settlement method (wire, draft, bank transfer between cross-currency accounts, etc.) becomes more important.  The use of electronic templates to facilitate recurring payment and settlement instructions minimizes the effort required from the bank’s and the client’s back-office staff to handle the transaction, thus saving time and money.  Automated email alerts for outstanding trades and settlement instructions provide real time information on whether the transaction is progressing as expected.  

Another by-product of the focus on client experience and the decision to provide more customisation is an increased focus on multi and even cross-asset trading capabilities. “An SDP that offers cross-asset trading capabilities makes it easier for clients to access products and services they may not have considered otherwise, and help the overall cross selling and up-selling process that is key to improving and strengthening the overall relationship,” says Spiropoulos. “For example, integration of cash management capabilities with transactional foreign exchange and money market products such as deposits, T-bills and bankers acceptances offer corporate clients more choice.  As clients become more successful, and their business grows, they start looking at solutions that go beyond delivery versus payment, and require credit facilities to trade forwards and options.”

 

 

Integration

In terms of the technology behind the SDPs, white-labeling solutions from third party vendors are becoming cheaper and better all the time, says Spiropoulos, and it is becoming easier for banks to provide their own SDPs to their clients.  “However typically, the biggest challenge is in integrating and maintaining such platforms to the bank’s pricing engines, credit, risk, front-office and back-office systems, directing deal flows to appropriate trading books, and supporting workflows to administer the platform and perform post trade analyses on client trades.  Robust electronic solutions that facilitate the whole trading process, front to back, are a key requirement in achieving economies of scale in today’s increasingly competitive and saturated market”  

Technology advances in recent years have also enabled the development of web-based SDPs (as opposed to heavy downloadable desktop applications), that can also run on tablets, to provide a more rich and satisfying user experience, says Spiropoulos. “Platforms that can successfully facilitate the client’s decision of ‘what to hedge’ and ‘when to hedge’ go beyond the traditional SDP offering, and require more proprietary technology solutions.  Initiating a query over a platform to retrieve historical FX trades is one thing, using those trades to provide aggregated future exposure information is something that both sales people and clients value, as it speeds up the decision cycle.  These and other innovative risk reporting capabilities with associated research for the time period in question is an area of growth for SDPs, with the boundaries between traditional research websites and transactional platforms being blurred.”

As the implications of new regulation continue to be a concern for both participants and providers in the capital markets, Spiropoulos accepts that there may be some profound changes, even if, at first glance, there is no glaring inconsistency between new regulatory proposals and existing FX trading platforms. “At a high level, electronic trading via single dealer or multi-dealer platforms is compatible with the increasing regulatory requirements in over-the-counter (OTC) markets.  The trend for more transparency, more straight through processing, more automated daily settlement and real time contingent credit checking, more automated trade auditing and reporting capabilities, more clearing facilities rather than less will continue, and electronic trading facilitates that.”

 

 

Clearing issues

However, there are still a number of grey areas that can have a huge impact on the way global banks interact with their clients in different jurisdictions, says Spiropoulos. For example, clearing requirements for Non-Deliverable-Forwards (NDFs), but non-clearing requirements for FX spot and outrights can be confusing for clients, as they would be required to post margin for cleared trades in addition to bilateral credit relationships.  The situation can become more complex for executing banks that choose not to become clearing members of CCPs, as both they and their clients would possibly need a new or existing bank clearing member.

Following that scenario through, if and when SEFs are mandated, unless SDPs become SEFs for those cleared products, all trading in those products will cease over SDPs, suggests Spiropoulos.  From a pure price making perspective, trading an NDF over an SEF will not be different to trading FX spot or forwards over multi-dealer platforms now – banks have been in price competition with each other for client business over such platforms for a long time.  However, this begs the question, why provide value added services such as trade ideas, market colour and research, over an SDP or over the phone for that matter, for a client to execute the transaction with another bank based on ‘best price’ at the time of the transaction?  

 

“For banks that actively promote partnering with their clients through both good and challenging market conditions for long lasting and deep relationships, the answer is simple,” says Spiropoulos. “It is the overall relationship that matters.  Our view is that being a client-focused bank, with a strong balance sheet and credit rating that extends loan facilities and advisory services to a client, positions us favourably to win business in the current market environment.  Clients that value their bank relationships will trade more over that bank’s SDP for the non-cleared non SEF traded products to take full advantage of all the pre-trade, execution and post-trade services that the bank has to offer.”

But, he concludes, “On the other hand, banks that have not invested in electronic platforms, whether single dealer or multi-dealer with auto-pricing and trading capabilities, that rely mostly on request for quote mechanisms and will not be self-clearing members of CCPs, will find it very difficult to participate in SEFs, and ultimately keep their existing client relationships.  Such banks will likely become more regional players with niche services limited to a small captive client segment.”