We have a new podcast episode out, this time with Investing Reviews Founder and affiliate marketing aficionado Simon Jones.
Simon and I talk about what life has been like since starting the company in 2020, what brokers can do to get the best out of their affiliate relationships, launching a new trading academy and other products, and what lessons brokers can take (if any) from the gambling sector.
You can listen via the links below…
A couple of weeks ago I was getting the tube home after going for dinner. It was a balmy evening and the Piccadilly line had that thick humidity to it that it gets on summer nights. All was quiet, bar the screeching sound the carriages make as they pull into a station.
Then the doors opened at Kings Cross. A man walked in with an old, worn-out disposable coffee cup in his hand. He was wearing a beaten up suit and his eyes were bloodshot. He looked like he hadn’t had a shower or shaved in a long time.
The man positioned himself at the end of my row of seats and I looked down awkwardly. I knew what was coming. My fellow passengers joined me in trying to avoid catching his eye.
“Good evening everyone,” the man said. “I’m sorry to do this, I don’t normally do it. But I have been looking for volatility for almost two years now. If you can please just give me a small amount of pandemic volatility then I’ll be able to pay my affiliates and IBs their rebates. It’s just a small amount for this evening.”
I looked down immediately and took my phone out. But it was too late. Soon he was standing next to me and pushing the cup under my face.
“Sorry,” I said. “I don’t have any volatility.”
“Come on man,” he said. “You know I’m good for it. Please. I’ll give you some great CPA, you know I can do it. I just need some volatility.”
“Listen, I know you don’t want to hear this,” I said looking up at him. “But that pandemic volatility is finished. You can’t get it anywhere anymore. It’s over.”
“It’s not!” he shouted and collapsed on to the ground. He whimpered something about hiring too many sales people and scrapping free fruit in the office.
“If it makes you feel better,” I said. “Gavekal said last week that the lag from rate hikes is only going to come through now. There is some slack in the labour markets in the US. There might not be a soft landing. David Belle said the same thing on LinkedIn.”
The man looked up at me. There was a small glint of hope in his eyes.
“So you mean…” he said. “Things can get worse?”
I crouched down, put a hand on his shoulder, and smiled.
“Things can always get worse,” I said.
Ok so that didn’t happen but you don’t have to be smart to realise that 2023 has not been a great year for the FX/CFD industry.
After getting high on their own supply because of the pandemic, we’ve seen some companies cutting headcount drastically. Recent reports by CMC and Plus500 show revenue per customer has gone down.
Given Plus500’s hedging policy is “yea, it will probably be fine” the implication of those results is that flow is probably in stuff that is harder to make money on. This is obviously bad news for anyone running thin margins and b-booking everything. From this author’s view of the market, there are some brokers who make you wonder if they will still be around in 12 months time.
But then periods of low volatility are basically the norm. So if you are a broker, is there anything you can do to try and make some more money when the line on the chart isn’t moving up and down as fast as you’d like?
Adding more products is a boringly obvious choice but it’s clear more brokers are coming round to it, purely because it makes you appeal to a broader audience. It is also one way of capturing more market share when there isn’t much happening.
There have even been some innovations on CFDs on this point, with eToro and Capital.com both marketing no leverage derivatives on products like oil and gas.
IG’s results, albeit with the caveat that this is in the US, also show the potential benefits brokers can accrue by adding options.
The main factors here seem to be cross selling or how profitable a product is on its own. For instance, stocks might be good for cross-selling but are not large revenue generators. Options, in contrast, have relatively good revenue per customer figures.
“Having more products and assets helps at all times,” said eToro UK Managing Director Daniel Moczulski. “If we are in the middle of a crypto boom, eToro can help with our crypto service. If we are having a stock trading boom, eToro can help with our real stock trading service. If markets are flat, or dropping, either can help with its CFD service. Having more assets, and products helps clients seek out either market opportunity, or to hedge an existing market risk.”
Some products do seem to be superior to others at this point in time. Much as they are loath to admit it today, IG Group was the first provider to launch binaries about two decades ago.
This was largely done because they offered shorter term volatility to traders, and could thus provide some ‘excitement’ when markets were calmer.
Today binaries are obviously not allowed in most places. But there are products that bear a striking resemblance to them. Deriv, for example, has a product called ‘Multiplier’ that seems to basically just be a CFD but with a knock out function. Maybe this is a bigger deal outside of Europe but given brokers have to offer negative balance protection anyway, I’m not sure quite what the appeal of this is.
Turbos, at least in Europe, are more similar to binaries and arguably offer the best alternative that a broker can hope for. There are a few features that arguably make these a bit more attractive relative to other offerings.
One is that they are more popular in certain countries, like Germany, than other products. Then there is the fact that they typically have investment banks as product issuers and are exchange-traded, things you would hope provide a level of regulatory protection. Given that IG, Swissquote and Saxo are the only major providers that offer them, there is also a level of meaningful differentiation here – not many people are doing it.
However, the big factor from a broker’s point of view is profitability. If you look at IG’s latest results, revenue per customer for trading on Spectrum Markets, the MTF it operates, was £2,300.
That includes other products, like warrants, which also offer some level of differentiation versus CFDs. For example, a cash settled call warrant on Tesla stock, with a short term maturity date, is quite a different proposition to a CFD.
Another option, and this only applies to the UK and Ireland, is to offer spread bets. These are surprisingly absent from some providers’ product sets, despite the fact they are really what the FX/CFD industry originated from and the benefits they offer in terms of attracting good clients.
The main reason for that is the fact capital gains on them are not taxed. So if you are minted, live in the UK, and have maxed out your tax efficient investment accounts, you may end up taking positions in equities using spread bets.
“Without really intending to, we have ended up specialising in spread bets on equities, particularly UK small caps,” Tom Salmon, Managing Director of Spreadex, told us. “It does require stumping up a lot of margin to prime brokers but the pay off is that we tend to have a consistent, sophisticated client base. That helps us smooth our revenues when markets are quieter.”
As that prime broker point hints at, this is not just a normal b-book model. It is more of an interest rate game, as you are effectively taking swap fees and commissions on exiting and entering the trades and then hedging your exposure. I guess you could not hedge your position but it would be a bad idea.
Aside from helping smooth out returns, it also attracts wealthier clients. Some of these are probably punting but others may actually know what they’re doing. Either way, wealthy people who punt for fun or who trade regularly and know what they are doing are good clients to have.
Beyond the fact that you have to put a lot of margin down, many brokers won’t do this because they just want to b-book everything. It’s amazing this has to be stated but this does pose risks. For example, we hear that one large broker has been hit particularly hard with gold trading this year.
Moreover, if you don’t hedge your exposure, the only alternative you are left with it is to make the terms of your trades very ‘challenging’. For example, some readers may remember the curious crypto trading terms offered by one provider in 2017, when trades could be only kept open for two weeks and interest on leverage was running at about 200%.
My estimate is that some providers may have no other alternative than doing this. If you are running thin margins on a b-book model, you cannot, and I would reiterate this is my intuition rather than fact, move to hedging your exposure. Doing so would mean you would then be in the red.
This points to why so many providers could end up crashing out in the next 12 – 18 months, sans volatility. You cannot keep bucketing trades because you are losing, but you also can’t switch to an a-book business because your entire model has been built on the former.
“The b-book has become the bane of a lot of brokers’ existence over the past 18 months,” Drew Niv, CEO of TraderTools told us. “They cannot monetise flow, so they are going to sleep at night wondering if they are going to wake up with huge negative P&L. But then they feel like they can’t pass trades through because their model doesn’t allow for it.”
Whether that can actually be changed in a meaningful way is up for debate. Some providers may simply be unable to hire the people necessary to do this. For example, Capital.com took a bunch of people from IG Group to build out their dealing desk across different time zones. If you are Plus500 and wanted to do the same, where would you hire the equivalent people from in Israel? The pool of local talent, which is strong in tech and marketing, is close to non-existent, even at the banking level, for dealing functions.
Another factor is whether this is actually a meaningful thing that can be done profitably. If you look back at the interview we did with an early IG Index employee, the hedging model…hasn’t changed that much? So is there really any crazy, ninja-like stuff you can do to make more money this way?
“There are definitely things you can do to manage your exposure more efficiently,” said a dealing executive at one broker. “But the risk is, if you don’t know what you are doing, you end up like your client. You are taking a view on the market, which is not something you really want to be doing.”
For Niv, the choice is not between being a pure b-book or running a hybrid model, but making tweaks to the way in which dealing desks operate.
“There is more you can do than just net off exposure and then hit an LP to hedge out,” said Niv. “This is basically the model that we are trying to get brokers to adopt but it is not what they are accustomed to doing.”
No silver bullets
Ultimately there is no catch all solution to the problems brokers are facing at the moment. It is likely to be a case of damage limitation, rather than a quick fix that will see them raking in the cash again.
“The way I like to think about it is we are similar to a cinema operator,” said Spreadex’s Salmon. “You can try some new marketing tactics or make the building nicer, but we are ultimately only as good as the films we put on – and volatility is the show that everyone wants to see. There is nothing inherently that you can do to really change that.”
I guess things can always get worse?