Interview with CEO Gabriel Styllas by ForexMagnates

From the April 2013 edition of e-Forex magazine
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Nicholas Pratt examines the issues shaping FX brokers’ use of liquidity management services and how they can be the difference between success and failure in an increasingly competitive market.

The ability to harness the growing number of liquidity aggregation tools available is a critical issue for FX brokers both institutional and retail. A number of varied factors influence a brokers’ choice of available liquidity provider- such as credit quality as well as price – and all of these factors have to be considered when building an aggregated liquidity management tool. For example, seamless support for electronic communication network (ECN) brokerage operations, low latency access to liquidity sources, provision of real-rime risk tool sets, support for marker maker and B- Book activity and integration with leading trading platforms are all relevant factors.

For retail FX brokers, liquidity management is especially important, says Andrew Ralich, chief executive and co-founder of oneZero Financial Systems, a developer of automated trade execution and routing software for the FX market. “As the number of participants in the FX retail space continues to grow, brokers are under increased pressure to find good quality liquidity for their clients in order to remain competitive.

This has created a demand for flexible and bespoke services that offer frontend platform connectivity, consistent execution m terms of rejection and slippage, and tight spreads across multiple asset classes. “Single-asset or traditional last-look aggregation systems are making way for new solutions which cater to the diverse needs of the modern retail broker, while providing a more institutional quality of available liquidity solutions, platform stability and speed of execution,” he says.

The choice of available liquidity providers is a complex one for brokers and one that warrants different views as to the best option, says Ralich. ”At the extreme ends of this continuum are the options of aggregating the maximum number of liquidity providers that you can or, at the other end of the spectrum, forming a close partnership with one exclusive liquidity provider.”

The factors that will dictate a broker’s choice are the spread shown, methods of clearing trades available, chance of slippage or rejection, and personal relationships. “There is no perfect configuration that has become standard across the FX market and each broker has to balance the pros and cons of each option into a carefully balanced matrix in order to ensure the best results,” he states.

Flexible liquidity aggregation A more flexible approach to liquidity engineering is enabling aggregation solution providers to offer brokers more customized liquidity pools and direct access facilities, says Ralich. “Cross-asset liquidity routing with contracts for difference and FX from a single solution, along with more intelligent order routing that is no longer based on just and A and B Book, are giving brokers more flexibility in terms of how they cross margin, risk manage and execute on their client flow.”

Liquidity management services also having to cater for the growing number of ECN and straight-through- processing (STP) brokerage operations. “These brokerages require tightly coupled reporting and reconciliation tools for their risk management and liquidity systems,” says Ralich. “Many of the traditional ‘bridge’ vendors are evolving their platforms to support more advanced reporting and liquidity controls in platforms already proven to work directly with the more popular front-end services like MT 4 and cTrader.”

In terms of brokers B-Book market making activities Ralich has seen a significant shift to what is being referred to as the C-Book. “This is where a broker realises that certain flows have value as B-Book business bur does not have the capital or regulation to run a B-Book on it. The more advanced liquidity providers are realizing that there is more value in capturing all of the flow from the brokers and then sharing more of the revenue back to the broker than there is in competing with many other liquidity providers in an A-Book model. This leads to much closer relationships between broker and liquidity provider and more exclusive revenue sharing relations starting all the time,” he says.

For brokers to get the most out of their liquidity applications, it is essential that they have the right mix of personnel and infrastructure, says Ralich. “It’s common to see a technology-focused broker miss the need for key business-oriented personnel to direct towards the clients’ needs or required market conventions, and it is equally common to see a broker full of business-savvy personnel but lacking the right technology experience to manage the platforms being installed. The brokers that find the right balance between business know-how and technology knowhow are the ones that are going to best manage and deliver their solutions. It is also important to consider the infrastructure the broker is using”

Combination of components

It is also essential to select the right combination of components, says Ralich. “There are many options available in the current marketplace, but a broker’s liquidity management solution is only as strong as its weakest link. This is especially true for ECN/STP Brokers. A strong liquidity pool is of little value if the Bridge component that connects the liquidity to the trading platform or front-end is weak, and vice versa. Some of the most sophisticated liquidity platforms in the world still lack a highly scalable means of addressing the unique trading characteristics of retail flow,” he notes.

Given the current competitive state of the retail FX trading business, more effective liquidity management strategies really can be the difference between success and failure, says Ralich. “There was a time when retail FX spreads were double those of the institutional market. This has now changed, with retail typically having tighter prices than institutional platforms. In order for brokers to compete in this environment they need to ensure they have tight spreads at least equal to that of their competitors. In order to do this it is important that a broker has effective liquidity management solutions to ensure they can maintain good relationships with all of their liquidity providers. Some of the successful strategies we have seen are customised streams for different types of trading and multiple separate liquidity groupings, such as exclusive and aggregated. If a broker fails to execute good liquidity management strategies they will see a lot of liquidity providers pull away from them or widen their prices, which will ultimately lead to an uncompetitive solution.”

Liquidity management services could ultimately shape the future evolution of the FX brokerage industry, especially in the rapidly developing retail FX world, says Ralich. “Behind every single trade, some participant in the retail market is taking on risk. Be it the broker themselves or a bank at the back-end of a STP /ECN solution. The sophisticated liquidity management tools and features previously reserved for the high end of the institutional market are now making their way into the hands of retail brokers and it will be exciting to see how this continues to evolve the quality of liquidity available to the end client.”

Sophisticated liquidity management

According to Stanislav Stolyar, vice president of FX Products, Devexperts, a financial software developer for FX brokerage, the liquidity management needs for retail and institutional brokers depend on the type of clients they serve and the nature of their brokerage activities. “We have seen larger FX brokerage houses, which are mostly B-book oriented, and they do not depend too much on the variety of liquidity since their biggest advantage is marketing and customer retention. On the other hand, an FX broker that has institutional-customers, professional traders or large net worth individual customers may have to employ sophisticated liquidity management solutions since the risk has to be managed effectively.”

Similarly, a brokers’ choice of available liquidity providers can be influenced by these same factors, says Stolyar. “If a broker needs multiple liquidity providers in order to manage the risks throughout the day, cost of transaction starts playing a significant role. In this case even personal relationship with liquidity provider and trust may become a key factor.”

In response, liquidity providers have developed a number of services to support different brokerage types, such as STP/ECN brokers or market maker/B-Book activities, says Stolyar. “For regulated brokerages even Tier-1 banks have started offering very flexible liquidity solutions that let them start their operations from relatively small volumes and over time grow into businesses that require prime brokerage services. B-book brokerages are less dependent on the liquidity sources as long as the feed is clean and reliable. Their business depends on marketing and customer retention solutions that really help them succeed and be different from the other market players.”

Brokers are also able to take steps to smooth the integration of liquidity applications and services with the trading platforms they use, says Stolyar. “There are specialised firms now on the market that can help FX brokers in the integration process of various liquidity sources. These firms solve all technical questions and let brokers concentrate on their core business: bring clients and manage risk. Technical support of the integration is an on-going story and is not something that comes for free. Every IT system requires periodic updates, including integration with liquidity provider.”

There is also a new generation of real-time risk and liquidity management toolsets that have emerged to meet the increased demand from brokers for risk-based services, says Stolyar. “With the growth of the operations that require liquidity solutions, brokers have become more demanding. They need to take into account various parameters that affect the decision where the order has to be routed. It includes cost of transaction, time of day, previous execution statistics and other risk-based information.”

Profit optimisation

According to Gabriel Styllas, chief executive of FX prime broker TopFX, liquidity management is essentially about risk management and profit optimisation. “Today, retail FX brokers still face a far easier challenge in managing liquidity than the banks. For the majority of retail brokers, low-latency STP execution combined with manual or automated exposure management is the basic solution they require. However, cost is always a factor for the retail broker and many are moving away from the overpriced, brand-name solutions and multiple liquidity providers. In addition, there is also a discernible trend in the market where retail brokers are moving away from liquidity providers who take risk on their own book.”

Ease of integration is also a concern, says Styllas. “A pure FIX API is the cutting-edge solution, while other GUI’s require specialized software bridges which are straight-forward to integrate. With FX volumes growing globally, strong depth-of-market and low-latency execution are now a standard requirement. STP is the starting point for retail brokers who either wish to hedge their exposure, to redirect toxic flow or to run a Book A business. For the standard day-to- day exposure management, a first-class GUI offers all the tools for manual hedging and for those who prefer a hands-off approach there is automated risk management software available. For example, if the risk posed by large tickets is to be managed 24/5, it can easily be resolved by combining STP with automated hedging software.”

There are some direct benefits that can be derived from gaining low latency access to liquidity sources – something that liquidity management service providers are cognisant of. “Even at times of high market volatility, an STP offer enables price improvement or minimal slippage. Also, high-frequency algorithmic trading becomes profitable for Book A brokers using STP where it used to be a risk for Book B brokers. Superior execution creates a win-win situation for both the broker and their clients. When profitability is maximized and losses are minimised, improved client satisfaction on all levels is the result”, states Styllas.

In addition to providing low latency access to liquidity, platform providers should also be able to help brokers with the smooth integration of their liquidity management applications and their trading platforms, says Styllas. “Retail brokers who are not WL and who aim to integrate tier 1 liquidity require in-house IT capabilities. Server support is a core function that the broker must manage due to the operational risks involved. Outsourcing this function is feasible through various software provides. API Integration is always important as FIX Protocol is the industry standard today.”

The constant challenge for Book B retail brokers has always been to identify and manage price-aggressive trading, says Styllas. By using an STP solution for liquidity management, they are able to retain the ability to profit from toxic flow. “It enables them to keep their clients who want to trade aggressively while avoiding a conflict of interest.

The STP option can be supplemented with automated software that modulates execution parameters per client, group or instrument. Unfortunately, some clients only realize too late how much money they have lost to aggressive trading. There are many retail traders prepared to take advantage of latency and instant execution malfunctions. When operating margins are tight, hundreds of thousands of dollars in P/L can be the difference between success and failure for a broker.”

In terms of future development, Styllas believes that liquidity management will follow the development of the market-leading retail GUI’s and the general shift towards more Book A retail brokers. “In the future, market technology and business models will intersect to demand even more sophisticated algorithms for liquidity management. At TopFX, we foresee an evolution from automation to artificial intelligence and machine learning software. Dynamic real-time liquidity management challenges will be resolved by programs rather than people.”

Costly relationships

One relatively new development in the provision of liquidity management services is the number of top tier FX banks and liquidity providers in their own right that are offering access to aggregated liquidity from multiple liquidity providers. CitiFX TradeStream, which was launched during 2012, is an aggregated liquidity solution aimed at midlevel institutions, removing the need to engage a prime broker or third party technology firm for price aggregation. “It is a fairly new space for Citi to play in,” says Alex Knight, Global Head for CitiFX Margin Trading business.

The rationale for Citi’s entry into this market is the recognition among FX brokers that despite the proliferation of various services, tools and platforms available, liquidity aggregation can be a costly process for many FX brokers. “The cost lies in the complexity of the relationship and the fact that whilst you can have a large number of liquidity providers, each relationship comes with its own overheads. There is an interesting tension between these costs and the technology available to aggregate liquidity,” claims Alex.

Citi is focusing on the mid-sized institutional customers, says Alex. “The larger brokers have the wherewithal to build their own aggregation tools and the balance sheet to engage a prime broker but there are those firms that don’t have the resources to manage every part of the process. Even if they use a prime of prime broker with an anonymous feed, they still have to maintain multiple relationships, and the brokerage fees are significant. With TradeStream they have a simple core relationship minimising the number of intermediaries, a great credit name and no big technology implementation. Almost every other solution compromises on at least one of those aspects.”

Alex also believes that Citi is one of the few large liquidity providers to have an offering configured for the smaller FX brokers. “Big banks do not have much affinity with tools like Meta Trader. If you are not able to deliver your prices through some of the key bridge providers, then you are not really relevant in this space. Customers dealing on TradeStream benefit from higher leverage than is available from a conventional bank prime broker as the margin checks take place pre-trade rather than post-trade.

Looking after liquidity providers

TradeStream operates on a full agency basis where Citi is one of a number of bank and nonbank liquidity providers. “Generally we provide our customers with access to all of the underlying liquidity providers except in cases where customers already have access to some of the same liquidity providers from multiple routes. An enormous amount of the success of this product relies on the premise that it provides value to the liquidity providers as well as our customers. As a leading market maker in our own right, Citi is very sensitive to the need to manage this balance effectively.

Where brokers are competing purely on price, it may make sense for them to dedicate resources to really optimise their access to liquidity. But where they are competing in other areas or if they don’t have the relevant skills, it becomes harder to justify that effort. It is not a trivial issue to create the best possible liquidity feed. To provide a truly differentiated price you need scale, multiple relationships and access to large balance sheets. Without these, it is very difficult to build your own liquidity pool in a cost-effective way, says Knight.

“There is so much technology out there and the prime broker infrastructure allows for credit intermediation meaning that there are almost unlimited potential relationships available. However, every time you introduce new relationships or if you add another technology provider, you have to remember that they all need to be paid and the costs can really become significant, as can the effort involved.”

Credit and counterparty quality is also an important factor in brokers’ choice, says Knight. “It is not just about the price, it is about the reliability of the fill and the reputation of the counterparty. Anyone can give a potential client a demo feed but this can often be a pointless exercise. The client wants to know how committed you are as a potential counterparty. If a broker is using a major bank with a vast FX franchise like Citi, they know that our reputation has only resulted from years of standing beside our customers and consistently providing them top-drawer service.