Analysis

Low Volatility & Regulation Pushing Some Brokers to the Brink

While institutional trading volumes picked up materially in Q2, retail brokers RPM continue to remain low

With the second quarter of the year now behind us, retail brokers are about to begin reporting on the outcome of another three months of very low volatility across major FX pairs. According to preliminary data, as evidenced by some public filings and privately shared information, brokers are struggling to remain profitable in the current environment.

While some companies have been well prepared with a multi-asset focused offering for years, others are struggling to remain competitive. FX trading has not been very popular among investors since quite a while back.

With the US dollar being indecisive and the most popular currency pairs being heavily entrenched in a tight range, retail brokers heavily focused on FX are struggling. Regardless of whether a firm is big or small, every brokerage which hasn’t played the diversification card is looking to be struggling in the current market environment.

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Rangebound FX Market

Since January this year, the EUR/USD has been range trading in roughly 300 pips. The most actively-traded pair by retail investors awaits the conclusion of a very heavy week where the market has to digest important central bank decisions, including the ECB this Thursday and the Federal Reserve next week.

While the expectations are for both central banks to ease monetary policy, the main focus of the market is on how much they do. That said, political and consequently trade uncertainty continues to drive the markets in the long run, and uncertainty is likely to prevail, which could mean a protracted period of low volumes.

As long as liquidity conditions remain the same, volatility on the FX market is unlikely to increase. In the meantime, brokers are having a very hard time to manage the flows from retail traders. Traditionally, range-bound markets have been positive for small-time traders, and this cycle is no different. As far back as April, GAIN Capital reported that it is barely earning $50 per million traded.

As shares of the company have traded near all-time lows for weeks, a rumor about a bid surfaced, sending the stock into a short squeeze.

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KVB Kunlun Losses

Last week KVB Kunlun guided the market lower on expectations that it will be reporting a significant decline in its revenues and would be materially impacted by the evolving regulatory landscape. Considering the exposure of the brokerage to the Chinese market, the news doesn’t come as a surprise. That said, the firm is not the only one that is struggling to remain profitable.

This example, however, is tightly connected to the state of the industry relying on Chinese clients to remain profitable. While many firms were quick to divest with expanding into other highly-populated areas in South-East Asia, KVB Kunlun might have been among those too slow to react.

Not Only Volatility

While volatility has clearly played a role, the bulk of the market is also impacted by the new industry landscape for the ESMA’s regulations that got introduced almost a year ago. Firms which have not invested heavily in geographic and product diversification suffered from a double whamming.

Not only the EU’s regulatory agenda has changed the market in Europe, but the Chinese government has cracked down hard on an industry which was already struggling to regain its footing.

Smaller Brokers Survive Offshore

While the big brokers are tightly bound to oblige to a set of strict rules when it comes to onboarding clients and advertising, other firms which are operating offshore are more flexible. The regulatory push in Europe, China, and now Australia is squeezing part of the industry very hard.

Sources deeply familiar with the state of the industry have shared with Finance Magnates that no broker is insulated in the current market environment. And while IG Group reported this week a significant decline in profits, the firm remains insulated and expects a return to growth in 2020 as its diversified offering and a global presence play to its advantage.

Adapt or Exit

With the sharp turn in the regulatory landscape in Australia, the only remaining safe haven for the brokerage industry in the G7 is about to disappear. With it, retail investors will end up having to make a choice – head to offshore jurisdictions to seek high leverage or accept different trading conditions onshore.

The latter would mean lower revenues for the brokerage industry in the current market conditions will continue until the ranges are resolved in one way or the other.

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