Foreign exchange has become enormously popular in Asia for both retail and institutional clients. Some say that the retail trading boom is down to a cultural affinity with speculation, others say that the institutional interest is a natural development of the globalisation of financial markets. Either way, it has become a beacon for international FX brokers eager to benefit from the opportunities on offer across the region.
Furthermore, the demand is spreading across the region from the established markets such as Japan, Singapore and Hong Kong to the countries on the periphery, in South East Asia especially. And then there is China – a subject all of its own thanks to a billion plus population and a stringent policy of internet censorship.
“The RMB clearing and trading business in London has also been a big boost to the demand for FX services in Asia, as the same currency pairs traded in the West are now being traded in Asia,” says James Banister, chief executive at FXecosystem, a provider of outsourced connectivity services to the FX market. This has in turn led to a greater demand for connectivity services among non-Asia based brokers looking to tap into this market. “It is highly attractive for a retail broker that wants to offer London prices to Asia-based clients.”
However, while the rewards on offer are enticing, overcoming the various technical challenges of network connectivity, platform selection, liquidity sourcing, data consistency and the Great Firewall of China can be a serious impediment to firm’s Asian ambitions.
The respective needs for retail and institutional FX participants looking to trade FX in or with Asia are similar but differ depending on the level at which firms are operating, says Banister. “The tier 1 banks want high reliability with low latency. For the FX retail brokers, most of their business is coming via the internet, so they have different demands,” he says. “There are also different levels of sophistication among their own clients, for example, those that are familiar with MetaTrader and have a good in-house IT provision and those that do not.”
In Asia, direct local routing is critical when it comes to reliability with Internet Service Providers (ISPs), says Banister. Some ISPs route their services outside the region, which can lead to slower levels of connectivity. FXecosystem has data centres in both SG1 and HK1 to try to mitigate these differences. Banister says that FXecosystem’s Asian experience has benefited from the discipline it has learned from operating between New York and London. Clients also benefit from its dedicated fibre in Asia which links to all the data centres in which FXecoystem has a PoP.
Part of this is looking at the credentials of the retail brokers it works with in Asia. “For example,” states Banister, “are they a start-up? Are they well organised? Are they regulated? In return, we would explain how our service works, with 24 hour support, a team in Asia and the type of services we provide such as virtual servers and fully managed connectivity.”
Brokers are also looking for a quick and scalable way to grow their business along with the security and protection around connectivity, says Banister. Consequently firms such as FXecosystem are looking to offer a package that satisfies both demands. “We differentiate between the institutional banks that want multiple connections, 15 to 20, as opposed to the retail brokers that are looking for 1 or 2 cross-connections. We’ve learned that it is paramount to have a reliable network and full support and the right people on the ground. It all sounds simple but putting it together takes organisation and engineers with the right skills that are fully synced up.”
The most obvious challenge to liquidity access is geographical or more specifically the distances between the retail client, their retail broker and that broker’s (typically Prime of Prime) liquidity, says James Dewdney, Institutional Sales at CFH Systems in Hong Kong. Most of the leading prime of prime brokers are based in Europe, typically headquartered in the UK with FCA regulation. These firms tend to host their infrastructure in data centres in London (LD4) or New York (NY4) and this exposes the brokers in Asia to potential latency. “In my view, irrespective of a generous organisation of points of presence or proxy servers, downstream clients of a retail broker may often struggle to get filled at the price they saw on the screen,” says Dewdney.
Yet the complex world of ‘latency’ is rarely straight-forward. “From a management standpoint, we are frequently faced with delineating the difference between ‘slippage’ and ‘latency,” says Dewdney. “Typically, it is the latter preventing customers from being filled at the exact price they clicked on. However, it is worth noting that sophisticated liquidity providers have tools at their disposal to mitigate slippage or price misses. For matched principal brokers such as CFH Clearing (aka STP or agency brokers), the way they interact with their own liquidity providers, where they do so and which liquidity providers they work with can make a material difference. Systematic models and Expert Advisor-types can host nearby to or cross-connect with their liquidity providers’ matching engine directly, thereby making the connectivity map effectively moot.”
Global brokers such as CFH Clearing offer co-location in Asia via TY3 in Tokyo, says Dewdney, thereby mitigating geographical latency with regional trade matching. “The general consensus used to be that Tokyo was not as liquid as New York or London and that meant spreads were wider. This appears to be increasingly unsubstantiated. Many prime of primes use proxy servers for APAC audiences but still match trades in London or New York. For me, a key principal of a quality prime of prime brokerage is being able to offer meaningful choices with professional insight and recommendations attached. There is no downside in a controlled trial and error process. In dealing with an established broker in Asia Pacific, I would favour accessing two liquidity aggregations in two data centres and monitoring the stability and quality of execution before making the decision with the client as how best to proceed. There are still a few questions in the weird and wonderful world of connectivity and data transmission that even the most sophisticated technologists can’t always fathom - being practical shines a light on the best route forward.”
Asian markets still need connectivity back to the major data centres. Pricing data will be going back and forth to New York and London and that can lead to latency and dropped packets because of the distance involved and the frailties of the public internet. Gordon McArthur, Chief Executive of Beeks Financial Cloud, says that the use of point to point fibre-based direct connections to the data centres is the best way to overcome the vagaries of latency and inconsistent performance. “A VPN is not going to help. Point to point fibre will give you a vast improvement in performance, reliability and security.”
Brokers are waking up to this fact says McArthur and are switching from the public internet to the point to point fibre. A contributing factor is the falling cost of providing this connectivity. For example, by using cloud-based servers, it is possible to pay less than a £1,000 per month, says McArthur. “Point to point fibre and direct connectivity is moving more into the mainstream and is no longer exclusively for high frequency traders.”
Credit and customer service
The main factors in serving the FX market in Asia are the provision of credit, the ability to deliver bespoke software systems and the dedication to customer relationships and service, says Rob Fleschler, Chief Executive of Seabury Global Markets.
“A lot of participants that are servicing the retail market find it hard to get credit, so they need to use a prime of prime or a broker. Credit leads to access and access leads to a broader marketplace. Even though you currently have a situation where even with a PoP, if your end client does not have a credit, you cannot close the loop. A top tier bank or market maker may have a prime broker, but if the end clients they want to service cannot get credit in some way, then it doesn’t work.”
Noble Bank International, part of the Seabury Global Markets and Seabury Capital portfolio of fintech investments, is set up as a collateral management and post-trade settlement service – as an alternative option to a prime broker or prime of prime, although Fleschler stresses that it is an additional option for FX market makers, traders and brokers rather than a replacement. “It is a peer to peer service so both parties are placing collateral with Noble Bank or with Noble’s custody bank. So rather than providing a line of credit, parties are pre-funding potential loss risk related to their trades. There are public and private pool aspects to the service and a variety of settlement options that range, from daily cash settlement to DVP. The service is not really aimed at those that need deliverable FX on a regular basis, but is targeting those clients that want the economic underlying position. Noble is a non-fractional reserve bank that allows clients to clear, net and settle in real-time and thereby reduces risk to participants. Accounts are segregated and collateral is bankruptcy remote so assets are protected. In some ways it has the properties of a clearing house or a CSD but without the physical assets or the membership approach.”
Bespoke software systems will help solve a lot of the workflow problems that may come up when providing connectivity and solutions to Asian markets. Another issue is latency. “In general, latency is a concern for all retail brokers and institutional clients using FIX and less so for any GUI traders. It is generally a good idea to have your matching engines in the region,” says Fleschler. Spotex is another Seabury Global Markets portfolio company, aimed at a more institutional audience. It has a matching engine in New York and is looking to add one in Asia. Seabury hopes to offer a peer to peer, CCP methodology alongside its current prime broker model. “In Asia we will add the alternative clearing model so that clients can pick and choose. If you have a PB but not the technology, use Spotex. If you need clearing and can’t get a PB or don’t wish to use a prime of prime, go to Noble,” says Fleschler.
Part of the reason for offering a choice of options is the growing sophistication of the client base in the region, says Fleschler. “Most of the major market makers are firmly established in Asia by now. New broker clients are also more discerning about where the liquidity providers are based. Now they are asking where you are connecting from, where’s your matching engine. I don’t think the trend for local matching engines or local direct connectivity is going away. People’s expectations are much higher now.”
The final and third component – customer service – is just as important as the technology, says Fleschler. “If you are willing to put in the time to offer a great service, you will be rewarded in terms of business. Asia, is a relationship-driven culture. New technology can certainly help to break down barriers but you still have to prove to clients that you are there for them in the long term.”
One of the ways to prove the commitment to the region is to adapt technology to the local market and to provide local support, says Fleschler. His firm has people in Singapore, Tokyo and Hong Kong and is currently in the process of establishing a presence in China via partnerships. “We are looking for legitimate trading partners, regulated local firms that will stand the test of time. We have all read about various enforcements that go on in China and licenses being revoked for overseas players,” says Fleschler.
The Great Firewall
China is clearly the biggest challenge for overseas service providers. It is a market with enormous potential but also several challenges for overseas firms, not least the issue of internet access.
The Great Firewall of China, otherwise known as the Golden Shield Project, was started in 2003 and completed three years later. The massive project was intended to act as a mass surveillance and censoring tool in regards to the internet activities of its population.
A number of amendments have been added since, further crackdowns on internet usage and information flow as a result of evolving technology such as virtual private networks (VPNs) that are used to circumvent the Great Firewall.
In January 2017 the government announced an 18 month rule during which time all VPNs would have to seek government approval in order to stay in business. The Ministry of Industry and Information Technology announced the change, declaring that due to the “disorderly development” of VPN and cloud-based services, there was “an urgent need for regulation norms” and the government would have to approve any services that bypass the Great Firewall.
“The Great Firewall of China is a challenge for everyone,” says FXecosystem’s Banister. “One way to deal with it is to have an on-the-ground presence in either HK or Singapore. It is also important to use local ISPs, have a good relationship with them and keep up-to-date with developments and changes. We keep high standards and insist that all of our clients are regulated so we don’t get caught up in any nefarious activity from non bona-fide trading firms.”
China is a separate case of its own when it comes to connectivity, says MacArthur. “The traditional approach is a non-workable solution when you are looking to use real-time data. You need to have connectivity with all of the ISPs and the networks and the brokers. It is possible to get secure connectivity to execute back in NY4 with servers in Hong Kong which adds a layer of complexity but to get direct connectivity with mainland China involves peering arrangements.”
“There has always been a fascination with speculation within the Asian population,” says Tom Higgins, Founder and Chief Executive of Gold-i, a leading provider of FX trading services for retail brokers. “So an asset class with good volatility and easy access is a good starting point. The market is still immature but it is growing at a faster pace than the US and the EU so it will soon catch up and even be ahead.”
Although one of the fastest growing FX markets is China, the potential profit on offer however is matched by the operational challenges involved, says Higgins. “You have to operate in the Chinese way and observe all of their rules. If you think you know China, you probably don’t. As a foreign company, there are only two ways to operate.
“One way is a to be a Wholly Foreign-Owned Enterprise (WFOE) and that can take up to a year and involves different accounting rules, pension payments, holidays, opening hours, invoicing, tax laws and other issues. The second way is to set up a representative office, which is easier but you cannot make any direct revenue. For service providers, establishing WFOE status is worth the effort but you are not allowed to act as a retail broker as a WFOE, you have to do it via a representative office. We separate China from the rest of Asia. You have to treat it completely differently. It requires a different mindset and operates with different rules. In countries like Singapore it is just like trading in London. However, in China you can’t just turn up and start selling.”
For hosting, retail brokers cannot host their servers in China because of the Great Firewall, says Higgins. “It is a serious problem. It is not a connectivity issue or about access to servers. It is more about specific websites that are blocked and that data gets throttled during busy times. So it is difficult to offer a low latency service. Everyone goes through the Great Firewall. It is not like the rest of the world. There are not enough pipes or bandwidth and a lot of filtering.”
Latency is another issue. “The level of latency within China is fine. We have web servers in China, within the firewall. There is not a problem with data coming out of China, it is data going into China that is the problem. This creates a range of issues, for example VoIP is distorted.”
It is essential to have a presence on the ground, says Higgins. “It is not good enough to have people in Singapore and to serve the whole region from there. Clients will be polite to you but if you’re flying in and don’t have an office, you won’t get sales.”
The need for a local presence will be even more pronounced if expected regulatory developments play out, says Higgins. “It would mean retail brokers could operate fully in China. That will get the big brokers involved who could look to link up with the local players so it will be key for service providers to have a local presence in order to become suppliers of choice.”
And what of other markets in Asia? “Australia operates more like the UK,” says Higgins. “There are plenty of MT5 products there and it is an interesting time with more brokers opening up every month. In Japan there is always potential but it never seems to happen. There is a huge amount of business in Hong Kong. FX is extremely popular but how will Hong Kong be impacted once China fully internationalises and opens its doors?”
China with a population of circa 1.35bn, nearly half of which are already online, and an expanding, highly educated middle class equipped with disposable income appears to have all the ingredients for a retail trading boom. However, a cloud remains over the future in terms of regulation of the FX market. “I would welcome some light regulation, says Dewdney. “In my opinion, it would signal the country is open to this business and the lights will not suddenly be turned out. That would encourage greater investment. A greater insight into government thinking would be helpful for all firms looking to operate an FX brokerage in Greater China.”
“If the rug was to be comprehensively pulled from underneath margin FX in China, I believe there is still enough business across the region to interest most overseas firms,”
says Dewdney. “Australia and New Zealand are obviously both compelling markets for margin trading. South East Asia is another focus. Thailand, Vietnam, Malaysia and
Indonesia have increasingly become markets with a meaningful number of clients.”
However the regulatory landscape is varied, says Dewdney. “I think most brokers would like to see an accommodative regulatory environment in South Korea and the Philippines, for example. Meanwhile, greater regulation in Singapore and Hong Kong has slowed the growth of retail trading through leverage caps. Of course the world over knows the magnitude of trading FX on margin in Japan, however very few if any Western brokerage firms have ever really ‘cracked this market’.”
Despite the challenges, FXecosystem’s Banister expects the market for connectivity services to continue, if for no other reason than the fact that these challenges are even more acute should brokers or banks decide to take it on themselves.
“Why take on the direct costs of network monitoring and people? For FX brokers, there is no sense in them managing their own networks. For a bank, there may be different cost drivers. We can get an outsourced service up and running much quicker than a bank could get its own infrastructure operational. And for an FX broker, it is possible to run a service on relatively light staffing levels but that can rise significantly if you plan to set up and run your own network.”
For brokers trying to do all of this themselves, the logistic and technology challenges make it an extremely difficult and expensive task, says Beeks Financial Cloud’s McArthur. “It is all about scale, you cannot do it half-heartedly, particularly in a market like China which is much more expensive operationally than other Asian markets. You have to take a long-term view and look on that expense as an investment.”