FNG Exclusive Interview… The issue of proper risk management technology and procedures has become very central in the brokerage community of late under the current very volatile global economic outlook. We sat down with Cristian Vlasceanu, CEO of Centroid Solutions and asked regarding the considerations that retail brokers should be mindful of for the risk management of their business.

Here is what he had to say.

FNG: Hi Cristian, and thanks for joining us today. Why do some retail businesses adopt a short-term view when making risk decisions? What can these retail brokers do to avoid making rash decisions?

Cristian: Some retail businesses tend to adopt a short-term view when making risk decisions, because it has to do with the nature of the business. The retail space is a very dynamic and fast changing environment. Many retail businesses fall into trying to maximize short term gains, especially when their businesses have just started, they are being “forced” to run a high-risk business model to cover their initial investment and operating costs, and this is very dangerous. It is very important for the long-term success and longevity of the business to focus on sustainability and consistency and to only take risk levels that the business is comfortable with, which requires a more disciplined approach to risk decisions.

However, it is hard to generalize the above across all players, as when it comes to risk management in the brokerage space, every company has its own view on trade risk management, what parameters to look at and when to make risk decisions.

Some businesses put an emphasis at the level of their entire portfolio, using VAR Analysis to quantify the level of risk they are comfortable with taking on, correlating it over many years of historical data, and frequently running Stress Tests to see the impact of market movements and market gaps at the level of their portfolio – and react accordingly. Other businesses follow a more client by client approach, analysing the trading behaviour individually, mapping it to specific risk profiles and taking routing decisions based on that. There are also businesses that follow a hybrid approach between the two, combining elements both at portfolio level and optimizing trade routing at a client-by-client level.

FNG: Do all retail brokers really understand the components of their risk P&L? How much of their risk do they make in commission and spread, and how much do they truly make on risk?

Cristian: Established brokers that have been in business for a long time normally understand all the P&L components as they have learned overtime (usually the hard way) to pay attention to all revenue drivers, and this can be seen from the published financial reports of some of the public companies.

However, when it comes to newer brokers, in general such a distinction (between the different P&L components) is not easily made by brokers. This is partly because some of the retail trading platforms do not provide such splits or statistics, or visibility available by default at the level of the platforms for the P&L, which can be misleading and certainly negatively impact the risk decisions.

The ideal scenario for these brokers will be to have access to the in-depth information about the components that make up the broker’s P&L – splitting between Spread Revenue, Commissions, Swaps, Risk Revenue and Principal Revenue.

Additionally, Centroid has carried out several internal analysis over longer period of time and found that it is important is to maintain and grow the Spread Revenue, as it is the consistent component of revenue, month in, month out, providing a reliable source of revenue for brokers, and allowing them to plan and budget OPEX and expansions accordingly.

On the other hand, the Principal Revenue, while it can provide outsized returns in given months, is varying greatly, swinging from way positive in some months to way negative in others – as it depends on the market movement and portfolio construction at the time. Therefore, overall, especially on a longer-term basis, the consistent Spread Revenue will outweigh the Principal Revenue, and account on average up to 70% of the total revenue.

FNG: Do brokers have the tooling to identify clients who are abusing them? What should they have to detect and mitigate these abuses?

Cristian: In general, not all brokers have the right tools to identify the abusers, because in the vast majority of cases, the retail trading platforms that brokers use do not really come with out-of-the-box risk related tools and information, so many brokers have very limited risk visibility when it comes to identifying these type of behaviours, which obviously is not aiding in making good and informed risk decisions.

To be able to quickly identify the abusers, either in an automatic and dynamic way, is very important, as the behaviour of traders can change very fast, so it is crucial to have a continuous / on-going assessment and adjust the execution models in real-time, at client level, and receive real-time notifications and alerts of such situations.

Being able to configure the behaviour and customize at an individual client granularity is essential, because the abuse may have come from a very few clients, and there is no need for the brokers to change the trading conditions of many (of all).

Having these capabilities is not easy and it comes down to the technology and trading infrastructure brokers have put in place, to ensure controllability, flexibility and scalability.

FNG: Do clients appropriately value other types of risk, such as counterparty risk?

Cristian: Counterparty risk is certainly something that should not be taken lightly, especially in today’s markets. The situation with FTX is a typical example that has brought these types of risks into focus now even more. It is important therefore to diversify, and not rely on single counterparties for the critical aspects of a broker’s business.

The issue may not be that brokers take lightly to counterparty risk, but that it is challenging to manage a trading environment with multiple counterparties, such as trading platforms and liquidity providers:

• Having such a segregated environment, with customers split across multiple trading platforms, means that brokers can lose the overall visibility over trade risks, and make it harder to take timely decisions when it comes to risk management; that is why brokers will need to find solutions that can bring this information together and provide the overall unified view and needed intelligence and controls, to manage risk efficiency.
• Additionally, when dealing with multiple liquidity providers, it is again very important to maintain adequate controls over the trading activity with each such counterparty, that are applied automatically at the level of the trading engine.

At Centroid Solutions, we have always been the promoters of diversification, as it is in the nature of what we do, be that in regard to having multiple trading counterparties, or more than one trading platform, diversified network and trading infrastructure, and so on. It has always been important for us, especially as a connectivity provider, to provide our customers with as many options as possible. That is why we have always prioritized additional integrations to trading venues as well as platforms, and functionality to help manage their setups.

Centroid Solutions also offers a comprehensive risk management system that consolidates and analyses trading data on a real-time basis, providing comprehensive risk management and analytical insights, risk alerts, complex simulations for the dealing room and executives of the company.