Squeezed: Inter-Dealer Brokers Business in Review
This paper analyses the Inter-dealer Broker business from a high level with specific emphasis on the importance to all IDBs of the datasphere. Covered are the 3 ‘majors’, BGC Partners, TP ICAP and Tradition plus up and coming Marex Spectron. Four brokers sounds like an oligopoly, however, the Interbank market is rife with cutthroat competition from companies of all shapes, sizes and flavours.
Stuck in the Middle, Long Term Trends
The exchanges are squeezing them from above, by pursuing strategies of buying low commission margin, but high volume OTC electronic trading platforms in Foreign Exchange (CBOE/Hotspot, Deutsche Börse/360T, Euronext/Fastmatch FX) and Fixed Income (CME/NEX, NASDAQ/eSpeed). This along with competition from MarketAxess (Bought LiquidEdge), and other electronic trading venues like LiquidNet and Tradeweb drives trades away from the less process friendly voice broking to cheaper more regulatory friendly screen based trading.
From below comes the threat presented by specialist brokers focused on specific asset classes. Marex Spectron has achieved strong growth through acquisitions such as 2019 takeovers of FCM Rosenthal Collins Group, CSC Commodities and recently Marquee Oil Broking.
Then there the ‘insurgents’, like Gottex Securities, and especially brokers in the Commodities, Energy, and Renewables markets such as EOX Live, Evolution Markets, and Vantage Capital Markets which leverage electronic broking to project reach and coverage that belie their size.
Not that the IDBs have been slow in acquiring smaller competitors, there has been Tullett Prebon’s ownership of PVM Oil and purchase of Louis Capital (2019), BGC’s 2016 takeover of Sunrise Brokers (Equity Derivatives) and in 2019 Ginga Petroleum (Energy) all of which have noticeably been kept at arm’s length operationally by their new parents.
Assets and Data
Yet the IDBs do have powerful, seemingly under-appreciated assets, like global presence with a network of strong inter-personal relationships which provide market intelligence, in ways analytics and numbers on a screen cannot. Their role in creating liquidity and providing price discovery in unstructured market places must not be under-stated. Electronic platforms are inefficient when trading illiquids because of a lack of willingness by investors to publicly show their hands in any market with limited buy/sell participants. Anonymity has its virtues.
The problem is as the markets become ever more data-centric, driven by analytics and algo-trading, and illiquids become liquid it becomes harder to compete when providing lower levels of price volumes, lack of market depth and inconsistent delivery.
The major area of growth for all the IDBs has been organic, despite small strategic acquisitions, with the notable exception of Marex Spectron. This has come off the expansion of financial markets in general and the push by investors to diversify their portfolios attracted by the potential of OTC markets.
Agricultural commodities have proven attractive as the world’s population explodes, metals driven by economic growth, especially China, and Energy markets switching away from Oil to gas and renewables. The increasing transparency now found in these markets has gone under the radar, yet played a crucial role in encouraging market participants.
However, all this was before Covid-19 swept onto the scene.
In terms of overall income the 2 largest IDBs, BGC Partners and TP ICAP are the equivalent in size of the large UK & European exchanges, though certainly not in market capitalisation, while Tradition can be benchmarked to Euronext.
• Average revenue of the 4 IDBs year ending 31/12/2019 was US$1,428 Million
• Information Services averaged 5% of revenues for the 4 IDBs
• The average revenues of the top 5 North American Exchanges (CBOE, CME, ICE, NASDAQ, TMX) for 2019 was US$3,757 Million
• Information services averaged 21% of revenues for these 5 exchanges
• The average revenues of the top 4 UK/European Exchanges (DBAG, ENX, LSEG, SIX) for 2019 was US$2,101 Million
• Information services averaged 25% of revenues for these 4 exchanges
As stated in an earlier review of CME, one way to judge one’s value is to have others measure it for you. In financial markets that measure is the market capitalisation.
If so then the market is probably not valuing the IDBs near their true potential, and certainly not close to exchanges or listed Multi-lateral Trading Facilities (MTF/ATS).
• Average market cap of the 4 IDBs US$1,368 Million
• Average price/sales ratio of the 4 IDBs is 0.96
• The average market capitalisation of the 5 North American exchanges was US$29,031 Million
• Average price/sales ratio is 7.79
• The average market capitalisation of the 4 UK/European exchanges was US$19,567 Million
• Average price/sales ratio is 8.9
One of the problems seem to lie in the IDBs Credit Ratings due to low balance sheet utilisation. The key to the IDBs is they are intrinsically a people, not capital, intensive business.
Unfortunately, transaction fees are by nature volatile, and like the exchanges, the IDBs need to grow information services as a more ’sticky’ source of income to balance out market volume highs and lows.
The IDBs data businesses have unique OTC market coverage, however, their information services businesses are not performing as well as their exchange counter-parts, who increasingly encroach on the IDB’s territory as they expand.
Data revenue growth at 26% (2017-2019) is performing above overall business levels of 13% (2017-2019) indicating changes in data strategies are having a positive impact, but still too low a base as a percentage of each business’ income
Factors to be addressed:
• More direct competition offering tradable data
• Over-reliance upon Bloomberg and Refinitiv for distribution with too much emphasis on raw data and vendor licence sales
• Not enough emphasis on enterprise data usage
• Need to widen the capture and publication of internal data, especially from specialist subsidiaries
• Eliminate revenue wastage due to poor reporting
• Need to identify new channels to market, leverage new technologies
• Engage with new types of data consumer and data usage, especially in the software solutions and informational services spaces
• Broaden the horizon beyond the primary market and large secondary market players
Keiren Harris 04/05/2020
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