It seems that every time I flick through the business section of the Evening Standard on the way home, the City Spy column is regaling the readership with tales of dodgy currency brokers laundering money, rigging currency markets and ripping off clients. It's a shame really because the vast majority of people working in finance are decent people just getting on with life in a service business, but as always the actions of a few ruin it for everyone else.
Since starting Berry FX I thought it worthwhile clearing a few things up when it comes to the world or currency trading.
There is a big difference between Forex and foreign exchange.
Forex generally means speculating on currency prices on a leveraged basis and is generally a bad idea for individuals as most lose money. Leverage enable traders to buy and sell far more currency than their account cash balances. Some brokers offer leverage of up to 500:1. That means that if a client has £1,000 in their account they can buy up to £500,000 versus the USD. A 2% move would result in a profit or loss of £10,000 in a relatively short period of time. When the EURCHF cap was removed and the price moved 20% it wiped out many traders and even some major Forex brokers. A trader with £1,000 on account and £500,000 exposure could have ended up being £100,000 in negative equity.
Foreign exchange on the other hand, is the conversion of one currency to another for a purchase or sale. There is no leverage involved with the exception of currency forwards.
Currency forwards allow individuals to convert currency at the current rates for a purchase or sale in the future. Currency prices can move so a currency broker will require a deposit of between 5% and 10% to cover the interim P&L on the position.
If you want to trade Forex you need a Forex broker, if you want to convert money you need a currency broker.
Currency forwards are an essential tool for international businesses and individuals wanting to budget effectively for the future.
Unlike speculating on the currency markets through a Forex broker, when you can either make or lose a lot of money very quickly, a currency broker can actually help individuals save a significant amount of money.
If for example, a couple are buying a holiday home, the process could take between six and twelve months. The GBPEUR exchange rate could move at least 10% in that time. So if the couple has £350,000 in their budget and the currency moves 10% the wrong way then the property will actually cost them £385,000. By locking in the current exchange rate using a currency forward, Euros can be purchased but not paid for until they are needed in the future, potentially saving £35,000.
Of course, the currency price could move in their favour, but the key point is that when it comes to the foreign exchange market it is very difficult to make money, but very simple to not lose money.
For businesses, currency brokers can make an even bigger difference. If a company imports goods from abroad and sells to UK consumers, currency fluctuations can reduce profit margins. By locking in monthly foreign currency purchase amounts with regular currency forwards margins can be maintained, cash flow can be accurately forecast and budgets set accordingly to increase profits and reduce costs.
Advances in technology and FinTech disrupting the industry
Over the last few years, especially since the introduction of peer to peer foreign exchange, FinTech (financial technology) has been reducing the costs for the majority of consumers. In the past, banks would charge up to £30 to send a payment as little as £10 abroad, fairly prohibitive behaviour. These new P2P currency exchanges offer to match small amounts of foreign currency with people in other countries wanting to make mirroring transfers. Transferwise for example, make a big deal about how they only charge 0.5% for any transaction and are cheaper than anywhere else. Of course this is fine for small amounts of money but is still exorbitantly expensive for larger amounts.
Financial technology is about connecting users to a service via the use of technology. The automation of the process, cutting out middlemen and therefore reducing cost. Fintech enables companies to be more transparent with their pricing. Foreign exchange is no different to any other market. There is a wholesale price, then there is a retail price. The more you buy, the closer the retail price is to the wholesale price. With the introduction of technology currency brokers can provide their customers with better pricing. For example, the Berry FX online conversion platform shows both the mid-market price and the customer price when a quote is requested so clients get true pricing transparency.
One important thing to remember though is that there is more to foreign exchange than just pricing. Timing is one aspect that technology cannot help with, and probably the most important. If brokers continue to compete on price alone, it will be a race to the bottom and consumers will ultimately pay the price. The foreign exchange market is probably not that far away from execution-only stock market brokers like TD Waterhouse or Hargreaves Lansdown, where any trade, any size costs £10. But unlike the stock market where people are trying to make money, foreign exchange is about saving money and protecting exposure. A little bit of advice from an experienced broker on strategy can go a long way.
Money laundering, excessive fees and wide boys
Currency brokers have changed a lot over the years. Foreign exchange is not about being wide, wearing pin striped suits and jargon that absolutely no-one can understand. Most currency brokers are now really technology salesmen who rely heavily on very intelligent people in t-shirts creating FinTech that powers their business.
The advances in FinTech also mean that money laundering is easier to detect and prohibit from the offset. In today's market everything is recorded, monitored, audited and client on-boarding due diligence is easier to conduct. Anyone who has worked for an FCA regulated broker will have at some point been scared witless when the compliance offices gives the annual money laundering training. The punishment for turning a blind eye, tipping off or even slightly being involved are so severe that to most brokers it's just not worth it. Many clients are reported just to be on the safe side.
In conclusion, excessive fees are clearly on the way out, but Fintech can only win half the battle when it comes to foreign exchange. As well as embracing this new technology, individuals and businesses must learn how to use it effectively enable them to fully reap the rewards.