“ICAP finds itself right in the middle of the maelstrom,” says 43-year-old Matthew Lester, CFO of London-based ICAP, Europe’s largest money broker with 2006 revenue of about €1.5 billion. That’s exactly where it wants to be.
ICAP’s remarkable rise over the past two decades, from one of many “voice brokers” (guys on telephones matching buyers with sellers) to the leading consolidator of an industry increasingly focused on electronic trading, has been based largely on its unmatched ability to read market trends. In the past few years, that has meant buying its way into new markets, especially high-volume electronic-based markets, exemplified by last year’s $700m (€497m) purchase of EBS, one of the leading electronic inter-bank foreign exchange trading platforms.
The EBS acquisition helped fuel a 153% surge in ICAP’s free cash flow last year, to €256m. But it looks like paying even greater dividends this year, as the summer credit crunch roiled the money markets and turbo-charged volume.
In August, ICAP reported record average daily volume through its EBS and BrokerTec platforms of $945 billion, up 51% on the previous August and including a record-volume day (August 16th) of $1.275 trillion, some $200 billion above the previous record.
As Lester says, “We are not position takers. We literally make money as people change their views or need to move their money around. That is very good for our business.”
Do you think it will continue like this?
If you track volatility over the last three or four years, it was on a steady curve downwards. What we’ve seen in this last calendar year may be — may be — a return to historic levels of volatility. The way we think of it is not on a daily basis but to ask, “How many periods of volatility are there in a calendar year?” You know: “Do you have one volatile month, do you have six volatile months?” What we’ve seen since May is that June, July and August have all been very, very active months.
What about the risks to ICAP’s business? For example, you’ve had an increasing amount of business coming from hedge funds, which might be seeing some of their money flows drying up. Do markets look like they’re changing fundamentally?
We haven’t seen in any of our markets that they’ve become frozen because people are too scared to do anything. Historically, even if you go through things like the Russian default back in 1998 or Long Term Capital Management when that went under [also in 1998], you didn’t see markets freeze. Provided markets don’t freeze, volatility is good for this business because as volatility increases, spreads move out and there is more money to be made between the bid and the offer. Also, you need to have good price discovery and more and more business goes through a broker. As a result, you find that in the more volatile, more challenging conditions, that is the time when brokers really come into their own.
Who knows where this current credit issue will go to but there is a large part of me that says we were seeing very unusual markets before, when credit spreads were very, very tight. As a result, we are moving back into a more normal period.
I’m not talking about banks not being willing to lend to each other [as occurred in late August and early September] but, generally speaking, this idea that risk should be properly rewarded, that there should be proper spreads out there, that you can’t just make money in any asset class as a one-way bet. I think we’re moving to what appears to be a more normal set of financial markets, even if moving from one to the other can be painful.
When you speak about ICAP being in the middle of the maelstrom, you also mean that it is caught up in a rapid shake-up of category definitions among major players in the financial markets — many client relationships have become competitor relationships, for example, as deregulation has broken up monopolistic exchanges. As Europe’s Markets in Financial Instruments Directive (MiFID), which is designed to foster even more competition in banking and financial markets, takes effect next month, this will add to the pace of change.
What is ICAP’s strategy in these changing markets? Will you continue to look for bolt-on or larger acquisitions to grow in new areas?
The strategy over the last five years has been to build the most effective global electronic network in financial markets while maintaining leadership positions in voice broker businesses. We’re sitting right in the middle of financial markets as they move through an unusual time here, where the exchanges have become for-profit organisations and their relationships with traditional banking customers, who used to own them, is changing. Banks also have a series of relationships with ever-larger institutions, which are clients of both the banks and the exchanges.
We’re looking, absolutely, for bolt-on acquisitions, particularly in new areas of voice broking. We’re trying to find new innovative areas where probably the businesses are still small and developing but with very high growth.
[Lester mentions growth in trade with Asia, which has fuelled ship broking, as well as emerging energy and carbon-trading markets.]
Then you have markets that are ready to go electronic. That is, they have gone through their growth phase, and it is a standardised product and can naturally be traded in an electronic fashion. Something like [credit default swaps] in Europe is a classic example — a market that only a year ago was being traded mainly by voice and now is very much an electronic market. The attraction there is that you make better margins.
Will this type of life cycle for financial market segments lead to fragmentation or more rapid consolidation?
It depends on the nature of the market. A voice business has the capability to retain four or five competitors. However, any electronic market naturally is a duopoly, because what you want is sufficiently large pools of liquidity where people know they can go when things get tough. But they need to ensure that it’s competitive and this is where the exchanges have had their criticism. If you have genuine competition then people are quite happy with two. What happens between exchange and [over-the-counter] — which part stays with the exchange — is the strategic question and I don’t think anyone knows. Our job at ICAP is to be best positioned whichever way it goes.
[In the US, senators Carl Levin and Dianne Feinstein are pushing legislation that would bring over-the-counter energy derivatives under the full jurisdiction of regulators, a move that may presage tighter regulation across the board for financial instruments in the wake of the credit turmoil.]
You joined ICAP as CFO a year ago after a long spell in various senior finance positions at €11 billion drinks firm Diageo. What differences strike you most?
Twenty-four years ago, I started my career in finance as an accountant focusing on financial services and, as it turned out, I spent a lot of my time on brokers, places like Phibro [now a commodities trading unit of Citigroup]. You saw then very much a focus on physical broking. There were bags of cocoa in the office, despite it being a leading-edge broker at the time.
What you see now is that derivatives drive the business. We must be doing total volumes of between $1.5 trillion and $2 trillion a day. The sheer scale of this place is the first thing that strikes you.