Forex Magnates spoke with Tom Higgins, CEO of Gold-i, for his assessment of the FX industry’s risk management shortcomings following the CHF fallout, whilst lending his perspective on the future direction of the industry. His interview can be read in full below.
1. What new risk management methods must be adopted to keep brokers from suffering great losses in case a similar situation happens again in the future?
I think it always surprised us how so many brokers don’t take risk management practices seriously, because its been so easy for them to just make money in the past. Brokers have seen that they can make an awful lot of profit without any downside – wherever there is upside there is downside however.
People who are not monitoring their risk, or client positions, or net positions, or doing sensitivity analyses are very exposed to any changes that can occur. Any change that does occur in their trading, or liquidity providers, or in their own back office systems, you frequently find that they are not prepared, or do not know how to deal with it unless things are working correctly.
In my opinion this is not a very sensible way to do business because you should be able to cope with the unexpected or when things go wrong. In the past it would have been just the middle office that would have been responsible for this, or to some extent the back office, but a lot of brokers have not put the focus on the front office, getting trades in the door, rather than focusing on the risk management.
Our background has always been from the back office or infrastructural side so I think that is why we have been able to build a very solid base of products with a very thorough understanding of how you would build a reliable business – i.e. from the back to the front, not from the front to the back.
Our first product we have ever produced was called the Gold-I Link, which took everything out of MetaTrader and put it into our back office, so we could analyze and know our risk using data.
2. Under what circumstances will the retail STP or ECN model remain sustainable?
I think you will see more use of STP because if you are a bigger broker now you could have been horribly caught out of position, or wiped out, or made nothing. What will happen is people will start to analyze their client profitability and begin to place the right clients in the right places so they will start thinking much more – we need to know whether clients should or shouldn’t be covered in the market. You need to analyze the work on how they trade, which liquidity providers, so you are not throwing toxic flow.
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This is one reason we developed our Visual Edge Tool, which allows you to analyze your profitability, which is built on our other tools to collect data from MetaTrader and allows you to see which clients are profitable and which are not, so you can know which ones you should cover and which ones you should not – using this information you can also work out the best liquidity providers for them.
So we have seen a growth in this product and there are a number of different modules that we are working on at the moment with Visual Edge, a real-time version that can be run every few minutes so we can strength the level of sensibility analyses that can be done.
3. What needs to be done to make the promise of “No Negative Balances” revenue neutral for retail brokers?
That is a difficult one, because if you say to a client that we will never let you get to negative but they can get negative with their broker then they will probably just have to utilize lower marginal products. Leverage will likely be reduced by brokers because they cannot take these risks. Rather than offering higher leverage, they might offer a reduced leverage.
Another situation that might occur is that they could just stop offering the option to not go negative, i.e. here is the risk you take, etc. I suspect you will see margins change, leverage change and fewer offerings where you cannot go negative.
4. Will this event lead more traders and regulators around the world to demand segregation of client funds?
Absolutely, I think most people will assume that their client’s funds are completely segregated. One thing that’s assumed about segregation is that you are completely isolated from other people but, in fact, you are all lumped together. I do not think you will have fully segregated funds because it’s simply too expensive to do, but certainly have your brokers segregate clients’ funds so you will not get into a bad situation.
We did a bit of an analysis in the trading volumes since this event occurred and there is not an awful lot of data to look at, but we did see spikes of volumes, and the next day it disappeared to almost nothing, then they picked up by about half, and now they have resumed normal trading volumes.
We were not really quite sure what would happen out of this, perhaps after getting burned some did not think this to be a game they wanted to play anymore, but this doesn’t seem to happen actually. We have a lot of brokers having a pause on broad-based changes. The phones stopped ringing for a couple days, and now they’ve started ringing again.
I think what will happen is big strategic plans will be put on hold. Businesses will review where they stand with compliance departments, and see how risky this is, perhaps leading to a more STP-focused strategy. This will lead to more people running better risk management. Again, its astonishing how many brokers do not do reconciliation with their liquidity providers.