Will white labelling stick?

The online FX market has continued to see massive growth over 2002. Banks have strategically looked to move ever bigger deal tickets into an environment where they can enable seamless automatic trading, without the high costs associated with human intervention. All the major players have continued to report shifts in the percentage of volumes carried out online.

The single-bank platforms have continued to develop both in terms of their business models, sophistication and product sets. As with all market plays, we are now witnessing a new phase in the development of the market -- white labelling. This is where a bank provides a white-label trading platform to its client banks, which use it to trade with their own customers and channel liquidity back to the platform owner.

One of the major drivers behind this is the need for the major players to continually evolve their model to attract new volumes -- and with it the flexibility that comes from increased liquidity. One of the most obvious places to find this is in the mid-tier banks who are simply failing to offer attractive prices to the market. Rather than look to trade directly with the plethora of small corporates, the major liquidity providers are now seeking to harness the relationships of these mid-tier banks to provide a flow funnel. In exchange for providing order flow from their regional corporate clients, the idea is that the liquidity provider will offer a branded e-FX portal with attractive prices. Everyone’s a winner: the mid-tier bank receives a branded e-FX portal that it can offer to its clients with competitive prices, and makes a margin, and the liquidity provider gets to gain yet more volume.

This all sounds good in theory, and Citigroup has already gone live with its offering, CitiFX White Label. In practice, though, there are a considerable number of issues that need to be identified and resolved, ranging from business models through to technology challenges.

The key question lies around how far the liquidity provider wants to extend into the trading chain, and there are two ends of the spectrum that we have seen banks seeking to pursue.

Basic model

At its most basic is the provision of a simple price distribution/order flow model. For the liquidity provider (the bank), a key question here is whether the investment in this level of service makes sense. For the relationship provider there is the sensitivity of its client base. At both the relationship provider and liquidity provider level there are questions with regard to credit risk ownership and management. Banks need to be prepared to provide options for credit risk management as a service through internal checking mechanisms or through integration to their client’s system. This is in addition to their own internal credit risk management obligations. All options present challenging operational and technical issues.

At the more complex end of the spectrum is a business model that seeks to turn the back-office function of the liquidity provider into a business opportunity. By offering a full trading, clearing and settlement link to the relationship bank as an ‘outsourced’ model, the liquidity provider hopes not just to bring in the order flow but also to take up the relationship provider’s cost burden from their middle- and back-office functions. Here, of course, the complexity arises as to which elements of the middle/back office the relationship provider wants to take up -- and complex workflow modelling tools have to be deployed to allow for different trade flows on a customer-by-customer basis.

A further challenge for any bank launching a white label portal arises from the support and operational implications of offering what is essentially a software solution. As client numbers increase, so the bank will find itself required to staff dedicated service departments, geared at resolving both technology and support issues. On a client-by-client basis they may be required to integrate and configure software, and as the client sophistication grows, be required to develop greater functionality and integration in return for retaining the order flow. This is clearly a move away from the core FX business and may be best served through an outsourcing agreement to limit the cost of a dedicated in-house team.

Not all plain sailing

The next 12 months will see the major players in this space jostling to either launch these white labelling models or to take positions that basically dispute the business benefits of doing so. Citigroup and Dresdner Kleinwort Wasserstein have already put offers into the market. It will be interesting to see how the likes of UBS Warburg, Goldman Sachs and JP Morgan Chase respond. However, it may not be plain sailing. Some of the intermediaries, such as [Reuters subsidiary] AVT Technologies, Cognotec and even the portals such as FXall, may have ideas as to how to offer a cost-effective solution to the mid-tier banks.

For some, white labelling may just turn into a white elephant.

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