In reflecting upon my experience in the FX markets over the last decade, I find it useful at times to step back and observe how the space has evolved. Looking back even before my time in the space, FX has emerged from a voice product in the 80s to electronification in the 90s and blossomed further into today’s modern market. In particular, I have been fascinated to observe how things have been changing since the heyday of retail FX, which I consider the period prior to the NFA (National Futures Association) clampdown in the U.S. retail market, just before the massive growth cycle that spawned incredible innovation in the brokerage, technology and regulatory landscape. From my vantage point, I believe the future of FX overall will be the inevitable convergence of the retail and institutional markets, and that the industry will trend toward a clear distinction between market participants and technology venues.
In 2008, I was initially enticed by the FX market because of the vast fragmentation of the industry. Unlike the equities and futures markets which were more rigidly defined, there appeared to be minimal standardization in how FX market participants sourced liquidity, managed risk and ran their businesses. This was especially true in the retail FX space, which at the time was beginning its ramp up into an ongoing growth spurt that is still building momentum today. At that time, the institutional FX space was 5 to 10 years ahead of retail in its use of technology.
Retail FX Markets Technology Inception
Retail brokers lagged in their technological sophistication compared to institutional participants. This was paralleled by minimal regulation. Where many institutional participants (such as banks, large prime brokers and hedge funds), had clearly defined jurisdictional and regulatory frameworks due to capital constraints, retail brokers had the luxury of playing “regulatory arbitrage,” or moving their firms to the least regulated jurisdiction required to conduct their business. As a result, retail businesses developed a relatively lax approach to technological consistency because of the limited requirements around how their business had to be conducted. One constant, however, was retail’s ability to demand a consistent front-end trading experience which started the era of MetaTrader 4 (MT4) dominance.
The MT4 phenomenon was an interesting, defining and thus notable aspect of the development of the entire electronic FX market, since the platform itself accelerated the ability to start up a retail brokerage. MetaTrader’s API accessibility spawned a vast marketplace of add-on, value add components. Even institutions and major investment banks’ pricing engines were tuned to handle the unique characteristics of this new breed of “hobbyist quant” retail transaction flow that began trickling up the value chain. MetaTrader was a new influence that delivered some uniformity to the retail space.
When we founded oneZero in 2009, we had a simple mandate to address the growing demand from the emerging MT4 brokers for direct hedging capability into the more well-defined institutional liquidity pools (ECNs and aggregation venues). We did so conscientiously from an early stage, with the understanding that the technological demands of MT4 retail brokers and institutional brokerages were relatively similar at their core, though retail was considered less sophisticated. The needs to manage spreading, discover prices, connect and distribute to venues were essentially the same architectural concepts. While many at the time considered retail requirements as a process of simply “dumbing down” institutional grade liquidity from upstream venues, in fact it turned out in many cases to be quite the opposite.
Retail FX Maturation and Evolution
Several key factors defined the retail marketplace’s maturation cycle and evolution in the early 2010s:
While brokers were still able to play regulatory arbitrage, the U.K., European and Australian jurisdictions were converging around how they governed retail FX which allowed those businesses to thrive. This was not the case in the U.S.
While there was high client and brokerage turnover, several firms began to emerge and be successful through the right combination of marketing, regulatory positioning and technology.
Those firms which established themselves as top tier retail brokers, such as FXCM, Saxo, IG, and CMC, all had the foundation of what I refer to as the “future of retail” well before the evolutionary transition I am about to describe. A critical differentiator of these firms was in-house technology not available to third parties. Many had constructed institutional-grade infrastructures that did not threaten incumbent institutional technology providers because they were not publicly available.
At this same time, a strong, healthy base of mid- and high-end retail brokers who had built their firms on the back of third-party technology emerged. These firms typically operated MetaTrader and accessed institutional liquidity using bridging technologies such as oneZero, PrimeXM or Gold-i, situated between the established top-tier retail behemoths and the dodgy bucket shops on the low-end. This middle market produced attractive, sizeable volumes that generated revenue upstream for the traditionally institutionally-dominated liquidity pools. This retail technology infrastructure began achieving institutional scale with high volumes of small average ticket sizes that created attractive, revenue generating flow for market makers, credit intermediaries and technology firms alike.
As these emergent retail enterprise firms continued to scale, two interesting trends developed. First, many of the traditional institutional platforms and clearing mechanisms servicing retail started to fail due to technology limitations as the underlying infrastructure strained under the number of tickets in those systems. Second, the retail technology platforms designed to handle high volume ticket flow began to rival the institutional platforms in their total collective enterprise value, delivering service at a fraction of the cost of traditional institutional platforms.
Enterprise Grade Solutions Give Rise to Outsourcing
Over the past two to three years, another relevant trend has emerged with the evolving availability of off-the-shelf, enterprise grade technology for retail brokers. The top tier firms who traditionally managed their own technology began outsourcing to support ever increasing “tick rates.” Technology built ten years ago, when the average tick rate was 100 milliseconds, cannot keep up with a 10ms tick rate, and certainly cannot manage a 1ms tick rate. Retail and institutional firms alike have found it challenging to operate as regulated market participants and to build technology platforms that can keep up with the rapid pace of change. As a result, major banks and retail players have strategically begun to outsource key aspects of their technology development to focus on their client relationships and position their businesses to manage the ongoing technological changes in this space.
Which brings us to where we are now: The beginning of hybridization of the retail and institutional markets. Technology venues that could successfully process and execute massive retail ticket flows have proven to scale nicely into the institutional space with faster tick rates. The workflow requirements to service the wide variety of institutional clients has already been built into the foundation of these platforms without requiring rearchitecting, whereas institutional platforms would require low-level changes to make the opposite transition to service retail. Market participants evaluating today’s landscape may question whether separate technologies would even be needed to service these different market segments. Furthermore, institutions can now grow their businesses with availability and access to a retail marketplace network and the trading flow that accompanies it.
We predict that as fragmented markets inevitably consolidate, it is likely that the future evolution of electronic FX will consolidate order routing, risk management and execution workflow as well. Buy-side market participants will always have slightly different consumption needs, and the sell-side will require unique distribution channels. It’s not a leap to believe that retail technology platforms will adapt their high-level workflows to accommodate less demanding institutional ticket volumes, while institutional platforms can gut their architecture to scale and accommodate retail ticket flow. Which will win out in the future? This author has an opinion, albeit a biased one, but I’ll leave it there and let the proof be in the pudding, as they say.