Is It Worth Launching a Forex Brokerage? Things to Consider

Ready to start your own brokerage? Better come with a pile of money or a unique idea first or be

In this report, Finance Magnates connects with experienced ex-forex industry professionals to hear their opinion on what they would do if they started over again and launched a broker today.  You can consider this article a Quarterly Report freebie.  Initially tagged to be included in the 3rd quarter report, other tasks by the writer caused it to be omitted.  So it’s a long one, grab yourself a cup of coffee and a comfortable position on the couch/recliner/beach etc first.

Before starting my career at Finance Magnates (called Forex Magnates at the time), this author had aspirations of opening an online forex brokerage. One of the first people I connected with for advice was Forex Magnates’ CEO Michael Greenberg.

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You can basically sum up our call like this:

Me: “Hi Michael, thanks for taking the time to speak.”
Michael: “Sure, no problem, how can I be of help?”
Me: “I used to work at such and such broker and I am planning to open up my own firm and wanted to get your advice on important trends in the market.”
Michael: “Forget all of that stuff, you need to have a lot of money to open a broker. Do you have millions of dollars ready to do it right?”
Me: “Um, no… I mean, not yet.”
Michael: “Do you have lots of clients already?”
Me: “A few.”
Michael: “Don’t bother.”

My experience

Like myself, there are scores of people working for brokers, with the feeling that they could do things better. In my case, working for a high spread (3 pip EURUSD) broker whose unique selling point was having good customer support, I felt that I could target the washed-out traders of these wide spread brokers and use superior technology to offer better pricing and trading execution. In my head, this all made lots of sense. I would offer a better product aimed at existing traders and would thereby have a lower cost per acquisition (CPA) than the big brokers.

The reality was just a wee bit different. By targeting existing traders, and not newbies, I was moving into one of the most competitive advertising markets. Apparently I wasn’t the only one that thought that customers of other brokers would provide higher lifetime revenues than newbies since they are already familiar with the product.

In addition, from speaking with marketing professionals that provided SEO and online campaigns for brokers, I learned of another problem: convincing customers to switch accounts. While in theory it makes sense that a trader who is losing money with his broker would be eager to switch to a superior offering, the reality is that converting customers from other firms is quite hard. Despite how much someone may hate their broker, there is the familiarity aspect that keeps them around. In addition, the broker can always provide an incentive such as free bonuses or lower spreads when they learn that their client is leaving.

For me, the bottom line was that all the number crunching I did couldn’t compensate for the fact that my CPA estimates were 50% lower than what I should expect when creating my business plans. For new brokers, beyond just having little clarity on CPA costs, other expenses that lead to high upfront expenditures for opening a broker include the regulation process, meeting minimum net capital requirements, and of course hiring staff and paying for rent.

Rising CPA

Among all issues, CPA costs were my major hurdle. This problem has only become more magnified in 2015, as new brokers can expect to pay $1500 or more for funded clients in western countries using search based marketing.

Other than requiring brokers to have a hoard of cash to acquire customers, the high CPA also forces firms to make sure their business models are equipped to squeeze out more (hopefully much more) than $1500 in lifetime value (LTV) from these customers. During 2015, this has proven to be a problem for quite a few brokers that are operating low spread, straight through processing (STP) agency models.

While an agency model in theory can reduce risk and minimum capital requirements, it is also less profitable than market making. As such, during 2015, quite a few small sized brokers have thrown in the towel due to rising CPA levels, or migrated their business model to include market making (more on the future of CPAs below).


Differentiating yourself to lower CPA

If I didn’t have a new idea that someone else didn’t think about, I wouldn’t touch the retail space with a 10 foot pole.

Speaking with marketing professionals, there are several different methods to decrease expected CPA. The most important one is brand building, where your name becomes synonymous with the industry such as FOREX.com, FXCM, OANDA and Saxo Bank. The better known you are, the more likely your ads are clicked on, which improves lead generating efficiency. But this can take many years and lots of money to attain.

Another method is through differentiating yourself. Brokers with an interesting product have the ability to generate buzz for their offering that attracts new customers. Regarding this method, Muhammad Rasoul, previously the COO at GFT and most recently the CPO at GAIN Capital but who has since left the industry to explore new opportunities, stated: “If I didn’t have a new idea that someone else didn’t think about, I wouldn’t touch the retail space with a 10 foot pole.”

Rasoul further explained that the industry is now too competitive to just offer what everyone else does. As such, he expressed that a new broker “has to be different” and offer a solution “that everyone would be interested in, fresh and ground-breaking”.

MT4 vs everything else

Todd Crosland, Founder, SeedEquity
Todd Crosland, Founder, SeedEquity

In terms of what that ‘something different’ is, this brings us to the next question of a platform. Do you launch with Metatrader 4 (MT4), build a proprietary platform or use another vendor? Doing something different with MT4 is obviously tough as nearly every broker offers the platform. But, with 45% market share among global (excluding Japanese) retail CFD and forex brokers, it is well known and is often the easiest and cheapest solution to get off the ground.

In evaluating the market, I saw what I view as a ‘sea of sameness’ among the different brokers.

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With regard to this dilemma, Todd Crosland, founder of IBFX and its former CEO, explained that after selling his firm to Monex Group and fulfilling his non-compete period, he contemplated a return to the retail forex industry. Crosland described his observation at the time: “In evaluating the market, I saw what I view as a ‘sea of sameness’ among the different brokers.”

Crosland explained that for him the main challenge was how a new offering could be differentiated. This led him to investigate different asset classes as a means to be unique. Crosland described that after evaluating numerous investment products, he came to the conclusion that early stage startup technology was a promising asset type class and was different to everything else. Ultimately, this led him to change his direction away from the forex and CFD industry and to create Seed Equity, an equity crowdfunding platform and SEC and FINRA registered Broker Dealer for technology startups.

Go big or go home!

In relation to products, Muhammad Rasoul explained that there are some niche areas that can be used to attract customers. Examples are innovation in automated strategy building, but he added that the reality is that there is “only a small pool” for these things, “so what’s the real revenue opportunity?”

Rasoul explained that to be a successful broker “the retail play is with tens of thousands of customers and not hundreds. Therefore, these other products should be seen as extras for a larger product base than a product leader themselves.” The importance of size is the scaling advantages that larger brokers benefit from, such as being able to operate larger marketing campaigns to decrease their CPA, and regulatory costs spread out over more customers.

As such, according to Rasoul, the goal for a new broker is to be able to introduce a new product type that not only differentiates them, but that can be scaled to a large audience. He hasn’t seen such an offering in years. But he did believe that perhaps there is room for a broker to have success in some emerging markets where the overall sophistication in retail trading is minimal.

Spreads

Muhammad Rasoul, former CPO, GAIN Capital
Muhammad Rasoul, former CPO, GAIN Capital

For new brokers, another important question to answer is how to price spreads. On the one hand, low spreads can attract clients but may be less profitable, with Rasoul explaining that with “lower spreads is it is hard to run a business with these low margins.”

On the other hand, higher spreads provide higher margins and greater rebates that can be paid to affiliates and introducing brokers. But then your offering is less competitive. Todd Crosland summed it up, saying that the “challenge is having competitive spreads to major firms like OANDA, Saxo and GAIN, and having something to differentiate yourself.”

In terms of differentiating oneself, there is a belief that brokers can get away with higher spreads by providing more of a ‘full service’ offering with personal client support and trading tools. However, Muhammad Rasoul questioned that assumption; “There is an allure of better products to get wider spreads. People say ‘we offer a premium service’ in order to get higher spreads.” However, he added that he doesn’t believe such premium services really exist to justify higher prices. “Everybody claims it but the reality is it’s all window dressing.” As such, the belief is that eventually, a broker will need to be competitive with other major brokers in their space to attract customers, and without something truly unique, it’s a fool’s proposition according to Rasoul.

Sales and support- top heavy vs lean

Among the last questions facing brokers is what type of sales process to use. In other words, how a broker wants to communicate with customers. Examples are calling every lead and pushing them to make a deposit and start trading and emailing customers to keep them engaged.

According to Rasoul, there are two general approaches that brokers can use: “There are two schools of thought, one is that you need to be working the phones to convert them proactively. The other one is that if you fine tune the experience to create a friendly and easy to interact with journey, then you can give them what they want and clients will self-convert.

Rasoul explained that for brokers, deciding which sales model to use entails understanding who their target customer is and what it takes to convert and service those customers, as well as accounting for the additional soft costs. Analyzing this process allows firms to better understand their real acquisition costs once they include headcount expenses related to sales and marketing staff and other soft costs not always attributed to CPA calculations.

Rasoul added that brokers can fine-tune their sales approach through several steps. One simple method entails focusing on engaged leads which Rasoul described as those which “have shown multiple interest in the company and trading over time”. The benefit is that brokers can maximize the value of their sales staff’s time and effort making proactive outbound sales, while hoping that the remainder of leads will self-convert through optimized journey campaigns .

Similarly, another method being used by brokers is automating the sales cycle with optimized email marketing. This entails optimizing email campaigns by matching content based on the sales funnel of the lead. For example, customers that clicked on a ‘silver trading’ banner will receive more alerts about precious metals and commodities.

Regulation = higher CPAs?

Circling back to CPAs, one last question to investigate is whether costs have peaked or will they continue to rise. Even if a broker is able to squeeze a profit with their current CPA models, they may not be able to in the future, as experienced this year by many smaller firms.

During 2015, quite a few small sized brokers have thrown in the towel due to rising CPA levels

One trend that is worth watching is whether regulation is behind the CPA problems. As global regulators have become more strict with forex and CFD brokers, more firms are electing to launch in countries with no or light regulatory standards. Taking advantage of the flexibility often means these many of these brokers are, for the lack of a better word, ‘screwing their clients’, and either withholding withdrawals, rejecting trades or closing without prior notice.

For such firms, bidding aggressively on search advertising is less problematic as they cover costs through aggressive revenue capture techniques. However, their actions affect brokers with smaller margins and are more tightly watched by regulators.

Bottom line

The bottom line is that there are many aspects to consider when launching a new broker. Arguably the most important ones are ‘do you have deep pockets?’ and ‘will you differentiate yourself’?’ Answering ‘yes’ leads to the operational questions of which sales approach and pricing to use.

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