Opinion

Europe’s move from OTC to listed markets

Jon Light, senior director of product management at Devexperts, explores the trend of CFD brokers across Europe moving to a multi-asset model, from why regulations are changing, to the importance of business model transparency, the role of neobanks and the evolution of traders themselves.
By Jon Light

A seismic shift is taking place in European brokerage. A market that traditionally limited itself to highly margined OTC trading products is now gradually opening itself up to exchange-traded equities and derivatives such as futures and options.

On the surface, this move is taking place in the name of a multi-asset and multi-instrument transition, which has historically been a way for OTC brokers to keep up with the shifting appetites of their traders.

However, a confluence of factors, among them increased regulatory pressure, rival venues such as neobanks and trading apps, as well as a much more educated and demanding retail segment, suggests that this may be more of a pivot than an expansion. 

Regulatory pressure

While in the past regulators have been content to limit leverage ratios and impose constraints on the advertising of CFDs, it now appears that the business model itself is coming under increased scrutiny.

What’s at issue, specifically, is the conflict in offering high leverage trading in an environment where the broker acts as principal, where both pricing and internalisation (B-booking) of trades is down to their discretion.

In Europe, a combination of restrictions and bans is limiting the access that OTC brokers have to consumers, with tightening regulations being top of mind for a large number of these venues.

Shifting business models

Switching over to listed stocks, futures, and options changes this dynamic, with brokers acting as intermediaries in exchange-traded instruments, where central order books increase price transparency and limit the manner in which spreads can be altered. It also means that brokers don’t benefit from client losses, instead generating revenues from commissions and fees.

This isn’t the first time an agenda such as this has been on the table. In the early 2010s, faced with pressure from traders regarding this inherent conflict of interests, some of the larger CFD brokers began moving to an A-book “agency model” where trades were passed straight through to liquidity providers. 

While the move lent credibility to the industry, these agency brokers were among the worst hit when the Swiss National Bank suddenly removed its currency’s peg to the euro in 2015, whereas B-book brokers that had internalized trades were spared from the freezing up of external liquidity as the Swissie surged by as much as 30% against the euro.

The event demonstrated the weakness of a pure agency model in OTC trading, leading much of the industry to drift back to B-book practices, or a hybrid of the two. 

Increased competition

A tightening regulatory environment and a need for business model transparency are not the only drivers of this change. Back when OTC provided the easiest and cheapest market access to retail traders, the US retail trading revolution was just getting started. At the time, mainstream access to, and understanding of, futures and options markets was limited.

Today, though, zero commission trading apps and neobanks are offering consumers affordable access to listed markets at a scale, while a deluge of online material, from forum threads to audiovisual content, has led to broader familiarity with the more complicated trading dynamics of futures and options, leading to more educated retail consumers. This is forcing OTC brokerage to adapt or get left behind. 

Final thoughts

Whether the entire CFD industry will be able to embrace listed derivatives remains to be seen. Smaller venues may opt to keep serving traders who value the relative simplicity and high leverage of CFDs via offshore regulation, or become introducing brokers for other firms who make the switch.

Larger venues certainly have the capital to implement the technological and organisational changes required, as well as to establish business relationships with executing venues and clearing houses. The lion’s share of this latter group’s revenues is still accounted for by OTC activities, and it appears that whether what we’re witnessing is an expansion or a pivot will become clearer in the coming years as the balance between OTC and exchange-traded revenues becomes more apparent on company balance sheets.  

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