There was a time when the Futures Commission Merchant (FCM) business flourished. In 2008, for instance, when interest income represented nearly 25% of revenue for the derivatives brokerage industry there were 154 FCMs, the vast majority independent. Profitability was relatively high and regulation accommodative. Fast forward to 2016 when interest income is nearly extinct and now only 70 FCMs serve the industry. In a world where nearly three-quarters of all assets are managed by large banks, a decided shift has occurred. In eight years the industry has faced many challenges, some of which have not been fully addressed. But the FCM space may be turning a corner, a new TABB Group report notes.
“The sanctity of margin funds remains a cornerstone”
“The futures industry is still dealing with the repercussions of the blow up of MF Global, especially since the issue of client margin funds were front and center with regulators,” a November 29 TABB Group report concluded, pointing to what was considered the core of market stability. “The sanctity of margin funds remains a cornerstone of the business and must be maintained.”
There is a concern that if a large bank, particularly in Europe, were to exit the regulated derivatives industry that void would be difficult to fill, particularly with current capital rules as they are and the majority of business going to regulation-strapped large banks.
The industry has weathered the MF Global and Peregrine Financial Group scandals, declining interest income, lower commissions and a torrent of regulations, however. In interviewing leaders in the futures brokerage industry, the TABB report noted key trends but also a sense of optimism that the tide was turning. In fact, 87% of FCM senior management now have a positive outlook on the industry, the TABB report revealed.
Managing profitability now a top concern with regulation as commission firmness is a positive sign
While FCMs have been “treading water” since the financial crisis, new trends are emerging that provide a glimmer of hope, with industry leaders outwardly “bullish.”
This bullishness comes from the sense that the wave of regulatory heat is behind the industry and they can now “pop their heads up to grasp for air.”
Managing profitability has overtaken regulation as the number one FCM concern as they are finding clients willingness to understand where the commission revenue goes to support the business. Fully 50% of respondents say their firm is operating ahead of the regulatory curve, while 26% say they are keeping pace and only 6% say they are behind the curve.
FCM now passing on data costs to clients and raising commission rates as clients understand the financial benefits they offer
A rarely seen firmness in regards to commissions is now apparent, with FCM’s actually raising transaction costs and passing along exchange imposed data costs to clients.
In the TABB survey, lLow touch, low tier trade execution commissions average $0.15 while high touch, high tier commissions average $1.77, with a range from $1 to $5. The average clearing cost is $0.31 for low tier business and $2.40 for high tier, with fully 73% of the FCM’s surveyed said they directly transferred increased data charges to customers. However, 75% of the FCM’s survived did not cater to the high frequency trading community, which would have brought down commission averages.
Many FCMs are finding that their business is being supported by research and auxiliary services which clients appreciate and pay for through slightly higher commission rates.
When understanding their client’s motivation to select an FCM, credit worthiness and a commitment to the FCM business model were ranked at the top, with client service closely following. Pricing and the ability to use futures commissions to pay for other services lagged. When asked why their FCM was better than the competition, 34.6% — the largest response by nearly double – said client service was most important. Balance sheet concerns, relationships with clients and quality of staff quickly followed with data infrastructure, size of business, cross selling and product offering trailing as competitive advantages.