A fresh approach to FX: interview with ADS’ Marco Baggioli
Marco Baggioli, Executive Managing Director of Global Brokerage at ADS Securities, tells FX-MM editor Peter Garnham why the business model in FX needs to change if firms are to thrive…
Credit in the FX market is still a big problem and it is likely to get worse, says Baggioli.
Indeed, as of March 1, additional margin requirements for uncleared FX kicked in, potentially making it more cumbersome to trade and meaning some smaller counterparties may lose the services of bank FX prime brokers or see the cost of using their services further increase.
As Baggioli explains, even if FX spot is exempted from clearing – and therefore from the margining rules under the new regulation – rolling spot is not. This means that any time a client rolls a position with a bank FX prime broker, it is now considered a swap and subject to both initial and variation margin.
“This all requires additional ISDA documentation, which is making it very expensive for firms to handle,” says Baggioli. “I believe this will put further pressure on smaller counterparties, because the banks will not be prepared to sign all this documentation with them if the trading volume does not justify the cost.”
There has been some leeway given to the banks by the regulators over the next six months, but by September the agreements need to be fully in place. For its part, Baggioli says ADS already has everything in place with its main prime brokers.
“We have been prioritised by our prime brokers because we give them lots of volume, but smaller firms are probably still negotiating with their banks,” he says. “It is one of the things to keep an eye out for over the next few months because it may put even more pressure on FX prime brokerages.”
For Baggioli, the measures increase complexity and costs to an industry where margins are already so thin that it makes him wonder about the sustainability of some business models. Indeed, it would appear to be another example of the unintended consequences of regulation brought in after the financial crisis, which has worsened conditions in the market.
“Trading is becoming more and more expensive, and with spreads remaining where they are, many trades are simply not profitable,” he says. “This may possibly shake the market down further in the future, with some firms exiting FX or reducing the business they do, or being more selective about who they do business with.”
Baggioli says ADS has seen the effects on the institutional side of its business. In the past, he says, the firm was able to extract value from and add value to its institutional clients pretty much across the board. Nowadays, the firm is more selective, prioritising profitability over volume.
“We stay focused on specific relationships that are mutually beneficial,” says Baggioli. “Volume is the least of my concerns, profitability is the most important thing.”
We try to target direct relationships first and foremost, either directly with the buy-side or with one layer of brokerage, providing firms that don’t have access to liquidity directly with prices that they can give their clients
ADS’s management information systems allow it to monitor the profitability of its clients across every aspect of the process chain, according to Baggioli.
“We know where the costs are located and have been investing in quantitative research capabilities to analyse how we deliver services to clients,” he adds. “That means for clients where we have higher rejection ratios, or where we don’t get enough execution, we clearly understand why this is happening.”
In that way, ADS can tackle the situation in one of two ways, according to Baggioli: improving the way it prices the client if it adds value, or simply telling the client it cannot service its business if it does not.
“We may lose some flow, but we increased profitability overall,” he says.
Indeed, Baggioli notes that there is very little margin left in the traditional market business model, where there is a continuous recycling of FX liquidity from broker to broker, or from aggregator to aggregator.
“That is why we try to target direct relationships first and foremost, either directly with the buy-side or with one layer of brokerage, providing firms that don’t have access to liquidity directly with prices that they can give their clients,” he says. “There is no value any more in being part of a long chain of liquidity.”