FXCM, the US-based FX and securities broker, filed a prospectus to the Securities and Exchange Commission on Monday for an intended initial public offering later this month.
The terms show the company hoping to raise $211m by offering 15.1m Class A shares at a price range of $13-$15 — a mid-point of which would give the company a market value of $1.1 bn.
Not bad for an IPO in the current climate.
Of course, what’s much more interesting is the story of FX brokering to be found within the pages of the prospectus itself.
This is the tale of FXCM’s transformational journey from principal to agency-model provider over the course of the last five years.
The story starts in 2005, with the bankruptcy of Refco — one of FXCM’s key white label partners which represented at the time as much as 40 per cent of total revenues to the business.
As FXCM notes, this is what really triggered the firm’s move to the far less risky and much more transparent agency-based strategy:
In 2005, a shareholder and white label (a firm that offers FX trading services to their customers on our platform under their own brand in exchange for a revenue sharing arrangement with us) of FXCM declared bankruptcy, at the time representing approximately 40% of total revenues, resulting in a significant disruption in the business that led in large part to the reduction in revenues and the loss recorded in 2006. As a response to such bankruptcy and its effects on the business, our senior management initiated fundamental changes to our business model, including the decision to transition to an agency model, which became fully operational in July 2007.
By the time the 2008 crisis struck, the changeover was standing ready to pay off for FXCM. Indeed, as others in investment markets crumbled, FXCM experienced what it called a ‘highly favorable operating environment’ with ‘extraordinarily high volatilities’ and ‘significant increases in customer trading volumes’.
Yet despite that success, FXCM is still only one of few major FX providers running the agency model.
Of course, with regulatory oversight creeping ever more intensely into the FX brokering space — FXCM hopes this may prove one of its biggest strengths in the months and years to come. As the group explains:
Many competing firms using a principal model can set their own prices as they generate income from trading with their customers. In contrast, the prices we provide to our customers are set by our FX market makers which vary based on market conditions.
And that’s because the FX market structure currently differs from the equity space:
Because equities are traded on exchanges, the prices are set by the best bid and offer on each exchange. Since 2005, regulations in the United States and Europe have required that equity brokers must present investors with the national best bids and execute those trades at prices that reflect the optimal mix of price improvement, speed and likelihood of execution.
In contrast, the prices that retail FX investors see will vary from broker to broker, depending on whether the broker uses a principal or an agency model.
Principal model brokers set their own prices, whereas agency model brokers, like FXCM, present their customers with the best buy and sell quotes from their pool of competing FX market makers. Execution of retail FX orders is also different from retail equities and, within retail FX, from broker to broker. For example, our agency model executes trades at the best available price provided by our FX market makers, including any price improvements that may occur between order placement and execution. We believe that the agency model execution we offer provides retail FX customers more transparent pricing and execution than that offered by our competitors utilizing the principal model.
Expanding our presence in Europe, a large market for retail FX trading We believe the retail FX market in Europe presents a significant growth opportunity for us due to our agency model. According to Greenwich Associates, a financial services market research firm, 57% of global FX trading volume in 2009 was conducted in Europe. We believe that awareness of the advantages of the agency model is growing among European customers and regulators, despite the current prominence of principal model brokers in Europe. We believe we can significantly expand our share of this large market through our existing operations in Europe and our acquisition of ODL.
Of course, what’s really interesting, we would say, is how the now clean-cut FXCM now views the merits of its old principal-model:
Our agency model is fundamental to our core business philosophy because we believe that it aligns our interests with those of our customers, reduces our risks and provides distinct advantages over the principal model used by the majority of retail FX brokers. In the principal model, the retail FX broker sets the price it presents to the customer and may maintain its trading position if it believes the price may move in its favor and against the customer. We believe this creates an inherent conflict between the interests of the customer and those of the principal model broker. Principal model brokers’ revenues typically consist primarily of trading gains or losses, and are more affected by market volatility than those of brokers utilizing the agency model.
Which summed up suggests that agency equals all that is good and transparent, and principal equals all that is conflicted in interest and opaque (with a touch of trading against customers potentially attached as well).
Of course, it does take one to know one. And the above is the comment of a former principal-model agent.
Related links:
The $100bn FX hustle – FT Alphaville
50:1 leverage lives! - FT Alphaville
Swiss regulator dishes out first forex license - FT Alphaville