I hate to bring up pornography for a second time in under a month in this newsletter but I need it to make a point. Needs must.
A couple of years ago, the FT did a great podcast series on the ‘adult’ industry, basically looking at who actually owns the major companies and how they go about making money. One of the key conclusions of the show was that payments companies, mainly Visa and Mastercard, have become de facto regulators of the industry and companies have to do whatever those two firms want to survive.
If you add in Google and Facebook then that will be an idea that many people in the CFD industry are familiar with.
Today CFD trading is a mature industry. There are lots of executives who know how things work. There are plenty of software and technology providers that make it very easy for you to start a broker. Just check the banner at the top of this email if you don’t believe me.
The result is that there are probably hundreds of people that could start a broker fairly easily and then know how to manage risk, market to clients, and structure their company.
But then you have two big roadblocks. As noted, one is the big social media companies, who will block your ads. This tends to be a surmountable problem for various reasons. A notable one is that most people who start a company tend to use IBs anyway, so Google or Facebook ads aren’t going to be their main focus.
The other problem will be banking and payments. From what I see, this is a much, much harder problem to overcome. There are numerous examples you can look at to illustrate this.
For example, one broker has had problems in India recently. If you look at the reports around that, a lot of it focuses on how they were getting money out of the country. The short version is that they seem to have set up a local company, which then used a bunch of e-commerce sites to facilitate payments. They then had to take that money and invest it into funds as a way of getting the cash out of India, which has strong capital controls.
This fits with a discussion I had about two months ago with an executive at one broker. They had been doing well in one country. There were no problems with the product, client acquisition or sales, and so on. But payments were such a headache that they just stopped operating there.
Similarly, if you speak to almost any broker consultant then, pretty much without exception, the first thing they’ll bring up is problems with banking and payments. Getting a license, for example, can be cumbersome and time consuming but it’s not that hard. But once you actually have the license then opening a bank account can be almost impossible – and that’s not factoring in then setting up subsequent payment agreements.
On the other side, I have had numerous conversations with people where they will claim that broker X or Y was able to do particularly well in a specific region because they could facilitate instant payments or something close to it. In other words, the quality of their trading product was as important or even secondary to the fact that they could make payments smooth and fast.
This is also coming for prop trading. If you look at a lot of props they will claim they are ‘education providers’. You have to wonder how long that will last and, from what I hear, some props are already starting to feel the pinch from banks and payment providers.
What is bizarre about this is that it seems to affect everyone. Even if you are completely ‘clean’ then you have banking problems. Props are also not regulated so, though you may have ethical disagreements with them, there is no reason that they shouldn’t be allowed to access banking and payments services.
Consequently you end up in insane situations like the aforementioned broker in India. As one broker executive put it to me recently, you are doing nothing wrong but are often forced to structure your payments in such a convoluted way that it feels like you are.
As to why this is happening, it basically seems to be part of a wider movement where banks have been forced over the last two decades or so to implement increasingly tighter risk policies.
A knock-on effect of this is also that compliance costs rise and so the ability to take on smaller business goes down. In some ways this mirrors what you see in prime brokerage, where the investment banks keep pulling away from smaller businesses, not because they don’t want to do it but because it’s not worth the hassle.
For brokers, the end result is that the industry has increasingly become a payments game more than anything else. It’s not a walk in the park but to set up a broker today, market to clients, form partnerships and manage risk is something that is at least within your grasp. The pain point is banking and getting money from point A to point B. The result is that much of the industry now feels like just as much of a payments game than it is a marketing or sales one.
