Jon Vollemaere was never one to shy away from a challenge, but his latest venture with R5 FX takes him into uncharted territory. He talks to Nicola Tavendale about his plans to boost liquidity in emerging market currencies, not launching a SEF from the start, American imperialism and why he finds voice brokers underwhelming.

Emerging market currencies, by Jon Vollemaere’s own admission, were rather unloved and over-looked in terms of electronic trading. But according to the founder and CEO of new interbank liquidity pool R5 FX, this market is rapidly becoming much more exciting.

In part this is due to economic factors, such as low volatility in the euro, dollar and yen as compared to the EM currencies, which are moving around rather a lot. Demand for the Indian rupee has been considerable this year, as well as other currencies such as Brazilian real.

This has not gone unnoticed by the banking community. Last year, Vollemaere says he was contacted by a number of London’s major banks which were looking for a technology solution to a shift they had noticed in trading behaviour. The banks reported a significant increase in demand from their clients for trading EM currency pairs, but because it is predominately a voice brokered market, the institutions could not electronically process these trades.

“After delving into it a bit more we discovered that thin liquidity is just the start of the problem,” explains Vollemaere.

“There are also problems with credit, problems with clearing and problems with regulation. In many respects it’s a green field opportunity – a perfect opportunity to build a fantastic venue taking the best bits of Reuters, Currenex and EBS et cetera and removing the bits that annoy people.”

Regaining Control

While the genesis of the concept was a handful of London banks, the new venue has been more than a year in the making with Vollemaere only unveiling it to the market in the last six months. He founded R5 FX on the back of the banks’ apparent concern not to miss the boat with EM trading and risk having everything just move to other platforms instead.

The pace of change for this market to transition from voice to electronic is also likely to be more rapid than past market evolutions, he predicts. “We’ve started from scratch rather than trying to retro fit onto an existing platform,” he says. “We’ve built this very much with bank goggles on and as a utility for banks. This is very attractive to them – at the moment there is an emotional feeling amongst a number of banks that they’ve lost some control of the market and now it’s time to take it back.”

This is hardly surprising given that a number of vendors in the past have directly targeted the banks’ customers, a situation the banks will be keen to avoid repeating. In contrast, London-based R5 FX will be an interbank pool only and claims it will be offering free market-making for the early adopting banks along with free market data.

Vollemaere adds that this was how platforms were run in the early days of EBS and Reuters, and is a model that traders miss. “Ours is a very future looking venue – but it does have its roots in what worked well in the past,” he adds. At the same time, R5 will also offer a rulebook in a bid to create a level playing field between the different approaches taken by buy side members, particularly high frequency hedge funds or non-bank market-makers.

“Their approach to trading is very different,” says Vollemaere. “Because they’ve been used to being the customer they can get away with pushing the boundaries a bit far. The moment you put them in a pool with everyone else and they’re all equals, the behaviours are different and many banks don’t like that. Ours is an interbank pool, they know the rules and that there’s no room for funny business here.”

Strategic View on SEFs

The new platform will be launching with 10 NDF currency pairs, in thin liquidity currencies: seven Asian, three Latin American. Once a liquidity pool is established, R5 will also look at the viability of building a mid-book secondary pool as well for non-bank market-makers, agency brokers and hedge funds among others. “This gives them a place where they can go and transact as well, without upsetting the core interbank market where the traditional pricing comes from,” Vollemaere observes.

Vollemaere claims to have received considerable support from the banks he is in dialogue with, and is now confident that R5 will launch with more than the initially planned group of 10 banks. “Everything we’ve built is in direct response to bank needs and feedback,” he says. “We brought together some of the good bits from the electronic evolution of the last 10 years or so, but perhaps curiously we are also starting with the model that began it all in the first place.”

The R5 FX platform is scheduled for launch at the end of Q1, pending approval from the UK regulator the Financial Conduct Authority (FCA). But perhaps even more telling is that it will not also be applying to launch a swap execution facility (SEF), or at least not from the start.

“R5 USA will be a SEF, but strategically we decided to not be a SEF at launch – we don’t need to be at the front of that queue, but will apply where to buy lexapro online further down the line,” he explains. “We have a strategic view that there is more desire for non-SEF trading than for SEF trading, particularly in Asia. Which is why we decided to go non-SEF first – there’s more than enough business between Hong Kong, Singapore and London to keep us very busy for quite a while.”

SEFs will also create a bi-polar market for a time, Vollemaere predicts, but adds that those banks that have the ability to play in both pools will do quite well out of it. In all, he expects the market to take at least five years to tweak and settle the new concept of SEFs into something workable.

“SEFs have already been a massive hindrance for everyone and it creates a level of uncertainty as well,” he adds. “It’s Economics 101 – you have a restriction on supply and the certainty of demand, which creates a black market. That black market represents SEF. Some US participants will find themselves in a situation where the price they pay is higher than they could have on non-SEF pools. You could argue that’s anti-competitive for US firms.”

 

Regaining Lost Ground

In contrast, he expects that SEFs will instead push a lot of American NDF trading towards London and Singapore. And he claims that between Toronto and Mexico City or Sao Paulo there is the perfect opportunity for non-SEF liquidity during the American day, which will come as welcome news to all three centres.

“We know that the Canadian banks have been beefing up their emerging market businesses, and this might be the perfect opportunity for them to take back some of the business that they lost to New York 15 years ago,” suggests Vollemaere. “The Latin Americans have a strong emotional and nationalist pride as well that says their currencies should be traded in Latin America. And why shouldn’t they be?”

Overall, R5 plans to wait and see how SEFs go for now. Vollemaere says he is in favour of the reasoning behind the change as it is “all about transparency, accountability and getting rid of all this smoky stuff that goes on in voice brokerage”. “And that’s a good thing, but you can still achieve that without having to be a SEF, which doesn’t really fit many of the requirements of this part of the marketplace,” he adds. “There’s a healthy amount of American imperialism in all this. I believe the world will not all go to America. America will have to meet the world in the middle and will have to create some kind of ‘demilitarised zone’ for the market in between.”

Due to the global nature of the market, attempts at establishing a central home do not pay off according to Vollemaere as they cannot be controlled like that. He adds that there are banks in Asia that have just opted out altogether following the introduction of the SEF rules, instead telling US persons that they simply no longer wish to trade with them.

Capturing Hearts and Minds

A significantly more pressing challenge for R5 will be convincing a predominantly voice-traded market of the advantages in switching to trading on an electronic platform.

Vollemaere is quite bullish about his prospects however, claiming the market is fickle and traders will go where the liquidity is. But the claimed benefits of electronic trading – lower costs, greater spreads, increased participants and transactions – may not be enough to win over the notoriously entrenched London voice-broking community.

For all his ambition, Vollemaere’s new venture is not setting out to replace EBS or Reuters, but instead has its sights set on the third incumbent in the EM market – the voice-traded world.

“It’s quite clear where we intend to take market-share from,” says Vollemaere. “Voice brokers are very good at convincing you to do things you don’t necessarily want you to do – but they are not very good at technology. I’ve seen many attempts and I’m underwhelmed. “But we do aim to be the third liquidity pool,” he adds.

“Both EBS and Reuters have their own internal systemic and strategic issues, which give us an opportunity. We can make the credit problems go away, make the clearing problems go away, and creating two liquidity pools shouldn’t be a problem. If anything, it’s a benefit. When you add all this together it becomes a great alternative.”

Boosting liquidity in the generally thin EM currency markets will be a formidable challenge, but R5 believes that by offering a cheaper alternative to voice trading it will attract more participants than is possible in the voice execution world.

The venue also plans to offer clearing through LCH.Clearnet, SGX and CME and any other mandated clearer once it is required. But the debate continues as to whether FX instruments need to be cleared in the first place. According to Vollemaere, perhaps they do not. “It’s fair to say that some of the US rules were in political reaction to the financial collapse; elsewhere in the world it might not be quite so drastic,” he adds. The R5 FX goal is to become the go-to place for e-NDFs and it expects to be eventually owned by the banks that use, and will continue to use, the venue as a utility. “2014 is the year of EMFX,” Vollemaere asserts. “Slowly those NDFs will become free floating currencies – as these economies grow and become part of the larger world we will be there to be a part of it.”