Internet Wave Hits FX Trading Market

With an estimated daily volume of $1.5 trillion, the foreign exchange (FX) market is the largest in the world. Historically, the world's largest commercial and investment banks have dominated the FX, or forex, market, offering so-called interbank dealing spreads. However, in the past several years, smaller firms have entered the industry, launching online forex trading systems and offering smaller spreads to small and mid-size investors--including hedge funds, money managers, corporate treasurers and private traders. There are many forex dealing services for different audiences. Some, such as Gain Capital and MG Financial Group, focus primarily on small-to-medium-size hedge funds and private investors, while others, like Reuters and EBS, target the interbank market. All, however, offer or plan to offer customers the ability to deal directly from live bid/ask prices 24 hours a day. Some of those vendors charge standard commissions, while others lure clients with smaller spreads and attempt to profit by processing large volumes of trades. MG Financial, Gain, Credit Suisse First Boston (CSFB) and MatchbookFX are part of a group of vendors that are pursuing small-to-mid-size buy-side firms and individual investors. The New York-based MG Financial, founded in 1992, targets hedge funds, money managers, individuals, and small to mid-size institutions. Basically, that target group includes anyone with a portfolio who is willing to speculate in the FX trading market, says Director of Marketing and Public Relations Roland Kaffaga.

MG Financial, through its Deal Station 2000 system, allows FX dealer to trade either directly or indirectly with each other. Clients of Deal Station 2000 can deal directly with each other via the so-called Internet Brokerage System; alternatively, clients can trade indirectly with their counterparts through MG's dealing desks. Gain, founded in 1999, began beta trading in March and is scheduled to commence live trading sometime this month. Mark Galant, CEO of the Warren, N.J.-based company, says GAIN will act as a market maker, offering institutional and individual investors commission free, real-time, 24-hour, Internet-based forex trading. The firm will execute FX trades of all sizes; traders will be able to conduct transactions of between $100,000 and $10 million at the same prices the interbank market typically provides exclusively to large institutional clients. Galant anticipates the company will execute "hundreds of trades per day" the first few months of live trading, and thousands of trades per day after that. The firm is mainly looking to snag small to mid level hedge funds and individual investors. CS First Boston, on the other hand, has rolled out Java-enabled, front-end workstation application in attempt to garner market share among small and mid-sized institutional investment firms. Dubbed PrimeTrade, CSFB's system covers FX spot, forward and swap instruments. Like PrimeTrade, MatchbookFX is going after the institutional market--but also is attempting to build a niche among sophisticated high-net-worth speculative traders. Minimum account size for the system is $10,000, but most accounts are in the six-figure range. "Basically, we're in the market for anyone who has traded highly leveraged instruments or derivatives," says Director Joshua Levy. Typical daily trading volumes on the MatchbookFX network are usually about $100 million per currency pair offered. In contrast to the aforementioned vendors, EBS and Reuters target an entirely different market: large banks. EBS, which caters to interbank spot foreign exchange players, has more than 800 banks using roughly 2,500 workstations on a closed proprietary network. Those clients transact an average daily volume of more than $90 billion on EBS' network. Reuters, which has been in the FX market for more than 20 years with its RMDS system, has rolled out approximately 21,000 of its FX workstations globally. Recently, the firm introduced its new Dealing 3000 line--its next-generation, interbank-market-oriented product line. "From direct feedback we've received from Dealing and FX users, we have developed a more open, flexible product," says Diane Domingues, a marketing official working for Reuters' money and transaction systems group in New York. "The 3000 line, for example, runs on a Windows-NT platform, which allows for a shared environment. Just as significantly, Dealing 3000 allows traders to view up to three different workstations that provide real-time news and quotes-- in addition to Dealing conversations and matching functionality. Traders also have the ability to carry on 24 separate conversations at once, and send broadcast one-way messages to lists that can have 100 or more counter-parties. Trade Clearance and Pricing While vendors in the FX market have different strengths and cater to a diverse array of investors, they all share at least one thing in common: the ability to clear trades. On the MatchbookFX network, Levy says, "there's no need for 'clearing' in the conventional sense of the word." Buyers and sellers trade directly on each other's prices, so the trades are effectively self-clearing. Buy and sell orders for any given currency pair, which are always instantly dealable, are displayed live on the network via Matchbook's so-called Open Limit Order Book Dealing Platform. Regarding commissions, MatchbookFX allows the trader himself to choose whether or not he wishes to pay a commission. Limit orders, or "passive" trades as MatchbookFX terms them, no matter how close they may be to the market, are always commission free. Only "aggressive" deals, which actually initiate a trade similar to an "at-Market" order, generate any commission charge. There is a maximum commission of $15 per $100,000 traded for inactive traders; active traders are charged as low as $5 per $100,000 traded. Like Matchbook, MG Financial Group is a self-clearing organization. The firm has a $10 round turn per unit trade fee, although accounts over $10,000 are not charged commissions when dealing through the dealing desk. Gain, which will also clear its own trades, plans operate on margin trading from day one. It will not collect commissions or charge fees. Galant says the company is hoping to turn a profit as the volume of trade's increases. "Even on a 5 pip spread, you can make money," he adds, "but only if you have good traders." Reuters' Dealing 2000 and 3000 products also are self-clearing. Reuters provides clients with various data feeds to integrate their trading information into P&L systems, middle and back office systems, risk management services and database archive systems. Customers pay a monthly subscription fee for the conversational FX trading service, as well as a per transaction fee for the electronic matching service. Partnering versus Building In addition to having different pricing structures, some FX vendors have different philosophies about buying and building technology. Matchbook FX, for its part, has relied on partners to build up its system. In late 1999, MatchbookFX incorporated Shadow Financial Services' clearance and settlement software into its infrastructure. The New York-based MatchbookFX--which lists hedge funds, banks and retail and institutional FX traders among its clients--is a joint effort of three partners: The NexTrade ECN, an SEC-registered ECN for U.S. equities; Valhalla Forex, a New York foreign exchange proprietary trading company; and GlobalNetFinancial.com, an international financial content web site provider. "Our three-way partnership adds a huge value to our organization," says Levy. "Each contributes in its own right to the team effort, creating the right formula for what we're trying to accomplish." In contrast, Gain, Reuters and MG Financial have developed most of their systems in-house. Gain's in-house staff--which did receive an assist from an technology "partner" the firm refused to specify--build the vendor's platform using Java push technology. Via Gain's Java-enabled system, information is automatically disseminated to end users.

Differentiating Factors Not surprisingly, all of the FX vendors interviewed by WS&T believe their products and services are different from their competitors. Reuters says the flexibility of Dealing 3000, combined with its reputation as a reliable and secure system, make the product one of the premier FX products in the market. Galant says what sets GAIN apart from its competitors, among other factors, is its "level of professionalism" and its dealing methodology. GAIN publishes the same live bid/ask prices to its entire client base, and allows any client to deal from that price, which means GAIN cannot "shade" or "read" its customers' positions. MG Financial, on the other hand, says it is different because its customers can deal directly through the service's dealing desks--on a 5 pips spread--or directly with one another on the IBS system. MatchbookFX, meanwhile, says its best differentiating factor is its instantaneous execution of trades on its system: all prices are live. "Situations where buyers and sellers are dealing directly and instantly on each other's prices are always better than if they had to go through some middleman marking up the prices," says Levy.

Another potential differentiating factor for FX vendors is the experience of their staffs. One of the major concerns of FX investors is the legitimacy and professional backgrounds of a vendor's management team--especially its traders. That's why some vendors have staffed their management teams with experienced Wall Street executives who have years of trading experience. "Credibility has been a problem for companies offering FX services," says GAIN's Galant. "There may have been some undercapitalized deals and questionable dealing practices in the past that have left customers wondering about credibility. But companies are working to change that perception, and one way is to assemble a trading team that is above reproach."