Two Strategies for Surviving Consolidation

There’s a word on the lips of everyone in the financial industry right now, and it’s not necessarily one people like to hear: consolidation.

For example, in perhaps the biggest news of the year, U.S. futures exchange CME Group got the green light in November 2018 from the U.K. Competition and Markets Authority (CMA) for its proposed takeover of NEX Group. The proposed merger was first announced in March 2018 and had been pending regulatory approval since; now, the entire industry waits with bated breath to see what this means for the future.

This merger was just one of many that happened in 2018, and consolidation is likely to continue in 2019, for three reasons. 

1 – Market data and network fees are far from inexpensive. Many smaller trading firms and proprietary trading firms (“prop shops”) struggle to cover these costs: Ketchum Trading shut down because “fees for essential services, like market data and exchange connections, have climbed so much that [the] proprietary trading firm wasn’t as profitable as it used to be.” Larger firms have the requisite larger economies of scale, making them better equipped to deal with infrastructure costs, but smaller firms are less flexible.  

2 – Market dynamics have made it harder to make money, even for players close to technology. With the surprise return of volatility, SocGen is considering shutting down its prop trading unit, and BNP Paribas already has. Another factor is persistent low interest rates, as many futures contracts derive their pricing from prevailing rates; if rates aren’t moving, the market isn’t really moving. The Federal Reserve raised rates four times in 2018, but this is likely to slow down or stop in 2019.

3 – Increasing competition is squeezing out even long-time players. At the end of 2018, Rosenthal Collins Group, the 95-year-old Chicago futures commission merchant, took steps toward selling its brokerage business to British firm Marex Spectron. 

So if a firm doesn’t want to be bought or shut down, whatcan it do to survive? Two strategies can help.

Take the same approach you use in competitive, mature markets, and airdrop it into emerging markets.

Look at markets like Australia, Singapore, India or South Korea, and find one that trades similar instruments. Transplant your same strategy into another exchange in which fewer people are competing to win the same trades, and continue to reap the rewards.

Unsure you have the resources to go international? Service providers are making it a snap to connect globally. A firm doesn’t need employees physically in the market, or deep knowledge of the network routes and hardware providers there, or local broker relationships. Service providers bring all of this, taking the tough parts off the firm’s hands and creating access formerly only available to global conglomerates.

Focus on the strategy, not the tactics. Firms that try to do too much can end up spreading themselves too thin, tying up resources and funds in the day-to-day tactics and technologies needed to run the business, and losing sight of the high-level goals.

Find ways to recoup some costs by outsourcing parts of the business, such as managed infrastructure and market data, that aren’t directly related to a firm’s areas of expertise – and focus on making money instead.  

Outsourcing helps maintain flexibility in a consolidating market, as does a smaller footprint, which helps a firm stay nimble and react quickly – an invaluable attribute, based on how fast things can change. For example, instead of building out a large dedicated presence in one data center, consider a smaller footprint in multiple locations with public cloud backup.