Executive Summary

The FX industry is no stranger to M&A. Since 2006, there have been 11 major transactions, with the pace only accelerating.

What's interesting about the 360T-Fxall merger is that the two companies occupy a market segment that dominates disclosed trading. In addition, with the uncleared margin rules set to hit users of $8 billion or more in FX Swaps, having a vertically integrated central counterparty clearing house (CCP) will out 360T-FXall in a great position to take share.

The foreign exchange industry is no stranger to M&A. Since KCG bought Hotspot FX in January of 2006, there have been 11 major transactions. The pace has been accelerating—six of the 11 have been in just the past four years. Yet, even in an industry that has become accustomed to mergers, the rumored acquisition of FXall by Deutsche Börse should make market participants stop and take notice. Both the scale of the merger and the strategy behind it represent something totally new, and its impact will reverberate throughout the markets.

brief history fx platform M&A

Merger Mania

To understand how this one is different, it’s important to understand the rationale for earlier mergers. The first few mergers were, in a way, vertical integrations. KCG-Hotspot was a market maker acquiring a venue, ICAP buying EBS was an effort for a voice broker to hedge its business model (spectacularly well, as it turned out), and State Street buying Currenex added a new platform and protocol to FX Connect, creating another way for State Street to monetize its custodial business. Thompson Reuters, the e-trading pioneer whose Reuters Matching became the original electronic communication network (ECN), acquired FXall in 2012, thus diversifying its platform offering to include a multidealer platform.

A new era in platform acquisitions began in 2015 with the BATS acquisition of Hotspot FX. This was the first time a major exchange operating in another asset class took out an FX platform for the purpose of diversifying its main business. This makes a lot of sense from the point of view of exchange strategy. FX trading volumes are relatively uncorrelated with those of other asset classes—the regulatory burden is relatively light, and the global nature of the product lowers the bar to geographical expansion and diversification. Also, given the scale economies inherent in the exchange business and the massive volumes associated with the FX market, you don’t need that many clients to run a profitable business in FX.

The BATS/Hotspot deal touched off a wave of similar mergers. Later that year, Deutsche Börse took over 360T, a major player in FX markets. 360T operated both an ECN and a fully disclosed multidealer platform and, so, was in a position to benefit from the migration from single-dealer platforms (SDPs) to multidealer platforms (MDPs). 360T was also originally designed with corporate treasurers in mind, so it had great penetration with corporate FX users—one of the most attractive client bases for liquidity providers. Then Cboe took over BATS and, therefore, Hotspot, which has since been rebranded to Cboe FX. Euronext bought FastMatch in a clean example of product, regulatory and geographic diversification.

The CME/NEX merger, which was almost as large as all prior transactions combined, had both vertical and horizontal aspects. The CME created financial futures with the launch of its FX product in 1972, so in asset class terms, it was horizontal. Nonetheless, the merger represented a significant strategic departure because the CME had never been involved in cash markets before. The combination of cash, futures, swap clearing, and a compression engine under one roof contains so many potential synergies that markets are watching the integration closely.

The most recent FX platform takeout was the purchase of GTX by Deutsche Börse; a bolt-on acquisition of a relatively small ECN to the 360T juggernaut. This brings us to the potential acquisition of FXall, which would be something else entirely—it would be a game changer.

The Mechanics of Platform Competition

To understand why, it’s important to understand the nature of the foreign exchange market, the kinds of platforms that have evolved and the basis on which those platforms compete. The FX market has the largest turnover of any asset class. Though there are corners of it that are less liquid than others, it is significantly more liquid than other asset classes. Furthermore, that liquidity is concentrated in a significantly smaller number of instruments—a handful of currency pairs. There are also a limited number of liquidity providers, primarily banks, though there are some nonbank liquidity providers.

Market participants access liquidity in a number of ways: over the phone, via single-dealer platforms, via multidealer platforms, and via ECNs. In recent years, banks and platforms have been granting access via application programming interfaces (APIs), which has led to the creation of API aggregators. These serve as synthetic platforms, aggregating liquidity from disparate sources but only routing, not processing, the transactions. SDPs were once the strongest segment, but there has been a steady migration to the MDPs. ECNs are a distant third in terms of volume.

There are two important differences between ECNs and the dealer platforms (SDPs and MDPs). First, ECNs are anonymous, whereas on the others, the counterparty is disclosed. The fact that the counterparty is not known means that trading on ECNs requires a credit intermediary, typically a prime broker. Since many asset managers, banks and corporations do not have prime brokerage relationships, many of them are effectively barred from trading on ECNs until the credit issue is resolved at a higher level.

For liquidity providers, particularly banks, the different platform types present a challenge. They have limited capital and technology resources, and they have to decide how to allocate among them. Banks get the widest margins on their SDPs because they have the least competition. But there has been a significant shift to multidealer platforms, and the greater volume may make up for tighter spreads. This dynamic has driven most market makers to connect to as many platforms as possible and provide some liquidity on each of them.

This creates an interesting dilemma for the platforms, making it very difficult to differentiate themselves in the way that the exchanges do in other asset classes. The liquidity is similar across all the platforms, and the disclosed nature of the trading limits how creative they can be with different trading protocols. So instead, they tend to innovate with workflows, integrating themselves into their clients’ very business processes. Take FX Connect, for example, which, paired with custodian State Street, has a full suite of post-trade services that can be seamlessly integrated with the back offices of many asset managers.

Platform Competition: From All Against All to Winner-Take-All

This has created a unique form of competition in the platform space. Among ECNs, competition is fierce. Their clients, who are all relatively sophisticated and whose business processes are intermediated by their prime brokers, can easily switch their flow between competing ECNs. The SDPs are also perpetually in competition with one another, if only because very few clients are comfortable relying on a single SDP.

MDPs, however, are an entirely different story. MDP clients tend to be extremely sticky and, since you can access multiple dealers through a single MDP, firms tend to use only one. Greenwich Associates data from 2018 found that the median number of SDPs used by clients was four, but the median number of MDPs was one. The MDP market is winner-take-all. What’s more, once a client chooses an MDP, they tend to stick with it. The intensity, and the effectiveness of competition over workflow integration, makes switching costs very high. The market shares have been so static that we actually stopped asking buy-side firms which platform they used in 2016. The data wasn’t yielding insights.

A Deep Dive on a 360T–FXall Merger

That’s what makes the 360T-FXall merger so unique. The two companies occupy a market segment that totally dominates disclosed trading. SDPs continue to contest what share they still have among the bank and corporate segments, but they have largely been swept from the field. SDPs don’t face direct competition from the ECNs either, thanks to the credit intermediation issue. So the organic rate of growth for the MDP segment as a whole is probably now the organic rate of growth for the FX market overall. This may or may not justify the kinds of multiples the owners of these businesses would like to have.

So, what is the operator of an MDP who is unhappy with the organic rate of growth to do? Well, you can either exit the business or you can grow inorganically—and with the 360T-FXall merger, we see two management teams making the equal and opposite decisions.

The decision on the Deutsche Börse/360T side is the easiest to analyze. They acquire a peer competitor that covers a very similar client base but with less overlap than you might think. The T in 360T stands for Treasury, and it was founded in Germany specifically to help German and European corporates manage their FX needs. The “all” in FXall is short for “alliance,” because FXall began life as a consortium of U.S. FX dealers. As a result, the 360T client base is slanted toward Europe, and the FXall client base is slanted toward the U.S., though both of them are global companies.

While there may well be some revenue synergies, there are absolutely cost synergies, as is typical in platform mergers. Given the client workflow integrations, these synergies may be harder to capture than in stock exchange mergers, but they do exist. There may also be operational synergies with Eurex Exchange and Eurex Clearing, other units of Deutsche Börse. With uncleared margin rules set to hit users of $8 billion or more in FX swaps (basically everyone using FX swaps), having a vertically integrated central counterparty clearing house (CCP) will put 360T-FXall in a great position to take share from SDPs. The creation of a market-dominant cash platform also puts Eurex Exchange in a stronger position to challenge the CME/NEX FX juggernaut.

So, what does Refinitiv get out of selling FXall? First, we have to ask the question of whether the deal is only for FXall, because Refinitiv actually possesses a number of FX assets. They could conceivably turn FXT into an API aggregator by connecting it to other platforms. They also own what may well be the oldest continually operating FX e-trading venue, the ECN formerly known as Reuters Matching. FXT and Matching are run separately from FXall, but it’s possible that Refinitiv may be exiting the business altogether by selling them to Deutsche Börse. If so, then that’s the end of the story: Refinitiv gets cash and it can pay down some of the debt that its private equity owners took out to purchase it and then plow the rest into the remaining business units.

But they may not be exiting entirely. If they’re retaining FXT and Matching, it says something very interesting about the SDP/MDP/ECN API aggregator competition. Given the operational synergies with Eurex and the need to compete with CME, Refinitiv very likely saw that Deutsche Börse could do better with the assets of FXall than they could. After all, the MDP business had been slowing. But by keeping FXT and Matching, Refinitiv could be betting on businesses with higher growth potential, and they might be looking to finance an expansion of FXT and an upgrade of the ECN with cash generated by the sale of the MDP.

All in all, the transaction looks like it could be a win-win for both parties, and it will probably force some very serious thinking at both FX Connect and FXGO. But, even in the event that it does not occur, and Refinitiv and 360T remain robust competitors in an intensely competitive field, the market realities that have driven the competitive logic to this point are ripe for reexamination.


Methodology

This report draws on Greenwich Associates research conducted with 2,369 FX investors globally between September and December of 2018. Respondents were asked to report their electronic trading activity across platforms. In addition, Greenwich Associates spoke with several industry leader to help guide the analysis.