In recent years, futures commission merchants (FCMs) have focused on creating efficiencies and adjusting to the “new normal” which included increased regulatory and compliance costs, tougher competition in a mature consolidating industry, dealing with aggressive product pricing from exchanges and perhaps most significantly, a more than decade-long low interest rate environment.
What has emerged is an environment with fewer but more efficient FCMs that have survived difficult times and come out on the other side stronger and more efficient.
As for 2017, it has been a strange year full of geopolitical and domestic crises, but without the associated volatility one would expect to come with such events.
“Frontline headline news has caused a lot of discomfort for many,” says Tom Kadlec president of ADM Investor Services, who adds, “Geopolitical headlines have not translated into volatile markets. Our volume is fine, but it is not exciting. VIX has been at half its average, the market has been in a slow grind up.”
Nicholas Lamaina svp of Strategy and Brokerage Services for TradeStation says 2017 was a good year despite the low volatility. “This low volatility and directional market have in some ways been great, but also lower the amount of customer activity,” Lamaina says. “We see customers go long and ride it out rather than actively managing their positions with the constant ups and downs of volatility. We are in a better place than we were 12 months ago. The interest rate increase have helped. We look forward to see where we are in 12 months.”
The Return of the Float
Of course, the most positive development over the last 12 months was the three quarter-point rate increase from the Fed after ending the zero-interest-rate policy (ZIRP) environment with one increase in December of 2015; and expectations of another rate increase in December 2017. Interest on customer funds had been a staple for FCMs, but dried up in the era of ZIRP (2008-2015).
“Interest income has historically equaled the bottom line profit for most FCMs,” Advantage Futures CEO Joe Guinan says. “The zero-rate environment was a particular challenge for FCMs and rates moving higher has aided Advantage as well as our peers.”
RJ O’Brien & Associates Chairman and CEO Gerry Corcoran says, “When the Fed raises interest rates it is helpful to our P&L. It was good to see it coming but we learned to live without it over the years. It was a long stretch of time when the Fed kept interest rates at zero; we learned to recreate ourselves in a lot of different fashions.”
Indeed, we have highlighted the consolidation in the FCM space over the years, and those brokers who depended on earning interest on customer funds could not survive seven years of ZIRP (see “Shrinking FCMs,” below).
“We have worked hard over the better part of the past decade to manage our business in a way that ensures we are not dependent on high interest rates in order to achieve profitability,” says Rosenthal Collins Group Chairman and CEO Scott Gordon. “When there are rate increases, they provide additional revenue potential and the prospect of higher volumes, but they are by no means essential to our daily operation.”
Interest income is critical because, as it had gone away, FCMs also faced greater costs from exchange fees, data fees, technology needs and regulation and compliance.
“That interest rate [income] helps to pay the costs of running the FCM, to keep cost low for customers,” Lamaina says. “Low rates put a lot of pressure on trading revenue. Now with some relief and a little higher interest rates, we will see a little more volatility infused in the market and can drive some revenue from more than just trading revenues and help to keep overall costs to the customers down.”
The ZIRP era did force FCMs to evolve. “Over this time, we focused on geographical expansion and product expansion with a discipline on managing expenses,” Corcoran says. “[When] the Fed went to zero in 2008, we were largely a U.S.-centric FCM; since then we have acquired the Kyte Group – a full European clearing firm; established very strong sales in Asia including in Korea, Hong Kong and Beijing; and built a tremendous global infrastructure.”
Corcoran points out that in 2014, 98% of RJO’s revenue was generated from domestic business, in 2017, only 76% of their business is domestic. “There is a vast middle market for RJO to serve. We have focused on our core strengths while transforming ourselves into a truly global entity,” Corcoran says.
“Higher interest rates are never a bad thing for FCMs,” Kadlec adds. “It is helpful to offset some of the rather aggressive fees exchanges charge us. While interest rates go up, exchanges continue to add to their fees. They added banking/custodial fees. Those types of charges that add up over time challenge FCMs.”