MDPs have “commoditised” corporate FX and crushed profit margins
22 October 2019 · 3 min read
Multi-dealer platforms (MDPs) like 360T or FXall have probably been the biggest innovation in the corporate FX space in the last 20 years, surfing the massive switch from phone brokerage to electronification.
In a nutshell, MDPs are trading venues connected to a pool of banks that greatly simplify price comparison and FX execution. They allow corporate treasurers to compare prices from different banking partners in real time and select the best offer (with a lower spread).
MDPs have been extremely smart in designing their business model. They decided from the get-go not to charge their corporate clients, but to ask for a “brokerage fee” from the bank that won the deal. In other words, they brought a lot of value to corporates without charging them anything — a no-brainer.
The beginnings were a bit challenging, with many leading banks in the FX space not really interested in joining the new MDP venues to compete for the best price — Deutsche Bank is known for having been the most reluctant — but now almost every bank participates.
The direct consequence for banks has been a race to zero; a massive compression of FX spreads for vanilla products and an erosion of revenue streams that were previously easy to capture.
In response to the threat posed by MDPs, banks have been focusing on more complex products like options. These are often tailor-made with prices (spreads) which are hard to understand and compare. While this is still a very profitable business, many corporate clients have a limited appetite for options.
Banks have also been developing complex technology solutions for very specific needs, like algorithmic trading, to smooth FX execution on large trades. In addition, they have created “simplistic” products like guaranteed FX rates that are very easy to use but that negatively impact firms’ price competitiveness. As they involve a markup, there are many limitations and lots of fine print, which may include tying a client to a single bank.
The reality behind guaranteed rates is that they do not require any kind of technology development and can be built on top of banks’ legacy FX platforms. This is also the reason why many banks are now moving in that direction, instead of trying to build unique FX technology from scratch which addresses real clients’ needs.
All these initiatives have leveraged bank infrastructures, balance sheets and organisations, to try to mitigate the revenue erosion caused by MDPs — although none of them was really focused on bringing highly differentiated technology and value to corporate clients. The common factor here was the shift towards products and services which made pricing comparison difficult.
With the benefit of hindsight, it is now very clear that the advent of MDPs was essentially a technology disruption of one part of the FX cycle, and that it was likely that most other parts of corporate FX would also be affected by tech advances, sooner or later.
As part of our development and product roadmap, connecting Kantox’s Dynamic Hedging solution to MDPs was a must. I think we started speaking about that idea in 2015.
Until recently, most of our clients were SMEs and mid-caps with revenues up to EUR 2 billion, to which we were providing FX liquidity. In other words, we were the counterparty to the FX trades, with Kantox sourcing its own liquidity from major banks.
With the bank partnerships we have recently announced (BNP Paribas in EMEA and Citi in the US), we have opened a new distribution channel. The banks’ corporate clients now gain full access to our unique technology, while obtaining their FX liquidity directly from their bank, or a pool of banks, via an MDP. In a nutshell, we are an intelligent software layer between the client (ERP) and the bank (FX liquidity).
This new channel has been an opportunity for us to better understand the value created — and the value destroyed — by MDPs, and how Kantox could create extra value on top of the existing setup.