Now that both Gain Capital and FXCM have announced their final results for 2010 (as well as recent results releases and announcements by others such as IG Group, London Capital Group, and FxPro), what exactly have we learned about these firms, and the overall state of the global Forex market?
A few observations:
1) It is possible for a retail Forex broker to build up a significant institutional business.
2) The “Wall Street” types really do not (yet) understand this industry.
3) Growth has slowed, but is still there.
Now, for the details……
1) Building an Institutional Business
Although the stock market has not been very impressed, we were when it came to Gain Capital’s results in building an institutional business. We believe that Gain succeeded in continuing to grow business significantly in 2010, where some others failed, mainly due to its successful launch of institutional trading via Gain GTX, its ECN for institutional traders.
In conversations with several firms worldwide, big and small, it seems to us that (virtually) all Forex firms want to attract larger and more stable high-net-worth retail and institutional clients, yet most are having trouble doing so. In its Q4 results presentation, Gain shows that its institutional volume grew from near nil in 2009 to more than 15% of its total volumes in 2010, hitting 22% of volume in Q4! Without the new institutional piece, Gain’s volume growth in 2010 would have been just 6.3%, versus its reported total of 25.5% growth. By contrast, FXCM – which launched an institutional effort well before Gain – did less than 9% of revenue in Q4 with institutional clients. With its rapidly growing institutional business, we believe that Gain is (slowly) closing the gap on FXCM as the #1 US-based Forex firm.
As Gain is showing us, it can be done.
2) Wall Street and the Forex Industry
It has not exactly been smooth sailing for either FXCM or Gain Capital / Forex.com since going public late last year. Both companies have seen their stock drop since going public – FXCM by 9%, Gain Capital by 11% (and that after Gain reduced its planned IPO price from $13-$15 to $9 per share at pricing!) – following on the combination of so-so results, lawsuits filed against Forex companies, and downgrades from Wall Street research analysts.
What surprised us, however, was the sudden about-face taken on the industry by the very Wall Street firms which took them public. In December a gaggle of Who’s-Who investment banks underwrote the IPOs of FXCM and Gain. And not surprisingly, the research analysts at these firms issued glowing recommendations of these stocks, with near-uniform price targets. For example, by mid January each of Citi, UBS, Barclays and Sandler O’Neill had $18 price targets for FXCM, JP Morgan had $17. (Aside: I thought that the days of “IPO Gamesmanship”, and promising positive research coverage were over! Are these “research analysts” each really doing their own real research and coming – amazingly – to the same “independent” conclusions, or just lemmings following one another off the cliff?)
By mid February, just 3-4 weeks after issuing their lofty price targets and glowing recommendations following (supposedly) months of doing research, some of these analysts suddenly realized that the numbers – to quote Citi analyst William Katz – “begin to suggest potentially greater maturity in the business than previously contemplated”. How could just one news release from FXCM (which did not provide such bad or different news from previously released) suddenly cause Wall Street to come to this conclusion? In our view, the Wall Street analysts did not do nearly enough work (if any) from the outset to truly understand the industry and its dynamics. Had they, they should have seen what we had, as we reported on falling / slowing trading volumes back in early December in our Industry Report and in early January in our predictions for 2011. Clearly, Wall Street has not yet done its homework on the online Forex industry.
3) Growth has slowed, but is still there
Continuing the theme from above, online Forex brokers had a so-so year volume growth and profit-wise in 2010. Markets and the online advertising universe are slowly becoming saturated. Regulation has made business more costly and has cut volumes (mainly via leverage limitations) in several key geographies, notably the US and Japan. And while the higher regulatory bar has also significantly increased the barriers-to-entry for new aspiring competitors, some larger players in the securities and trading business are entering or looking seriously at entering the industry – a thank-you to Adam Kritzer’s blog for pointing this out.
The firms which are continuing to show growth are those which, in our view, are continuing to innovate. For example:
- Gain Capital successfully launching a branded institutional product.
- Saxo Bank inking several large and serious White Label clients, such as Citigroup and more recently Microsoft’s MSN.
- AvaFX introducing a branded debit card, allowing clients to have access to the funds in their Forex accounts everywhere they go.
It is becoming very clear that as this industry continues to mature and (somewhat) commoditize, Forex brokers are going to need to actively innovate in order to grow and survive.
And finally, one brief prediction – February will turn out to be a great month for the Forex brokers (albeit having the fewest number of total trading days), due to the volatility in virtually all markets following the events in Egypt, Libya, Tunisia, Bahrain, et al.:
- The Dow climbed from 12,000 to about 12,400, only to fall back to 12,000,
- The EURUSD fell from above 1.38 down to below 1.35, then back up again,
- Crude Oil prices bounced from the mid-$80’s up to above $100 a barrel,
- Gold climbed steadily to well above $1,400 an ounce.
And in simple Forex mathematics, increased volatility = increased trading volume = increased revenues and profits for the Forex brokers.
Which Forex firm should I trade with?
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