The fact that FX prime brokerages sometimes prefer not to know the identity of a prime-of-prime’s end-client – to avoid being forced to carry out checks on that client – should not lead to concerns about systemic risk building up at prime brokerages, argue prime-of-prime providers.
Gil Neihous, Fluent
Gil Neihous, CEO of Fluent Trade Technologies, is one of those who thinks this potential for risk exists.
As is Louisa Kwok, head of prime services sales and product at ADS Securities. "It must be remembered that one of the original reasons behind the development of prime-of-prime was for brokerages to take on risk," she says. "If the prime-of-prime service is no more than a broker selling on aggregated liquidity, with little or no disclosure, there is no additional risk management. The FX prime broker is then exposed to the risk the broker accepts. Another event, such as the [Swiss National Bank de-pegging its currency in 2015], would lead to the same results and potentially a further reduction in the overall number of prime brokers offering credit lines for FX trading."
However, Raj Sitlani, managing partner of prime-of-prime services provider IS Prime, observes that if a prime-of-prime broker is carrying out its role professionally, it will inevitably take a protective stance towards its “Street LPs and prime brokers” that would mitigate any potential systemic risks emanating from end-client flow.
Others agree with that analysis.
According to Gavin White, CEO of Sydney-based multi-asset brokerage and prime services provider Invast Global, suggestions of potential systemic risk undersell the sophistication and prudence of the prime-of-prime industry and its relationship with prime brokers.
“We are supported by three tier-one prime brokers and communicate openly with all three about the profile of our client base and our due diligence and onboarding procedures,” he says.
Indeed, he suggests the model has matured to a point where individual prime-of-primes could fail without bringing the whole edifice down with them.
What has evolved is an intermediation of risk – a waterfall of prime services providers, almost a natural equivalent to the default waterfalls that are inherent in the structure of CCPs, says White.
“This waterfall provides the flexibility for the industry to cope with the inevitable failures of individual firms without being a risk to the system as a whole,” he says. “I feel safer with that structure than when all risks were pointing solely at the small number of global tier-one prime brokers.”
In this context, the lack of industry consensus on the necessity of pre-trade risk control surprises Justin Boulton, head of FX prime brokerage at FXCM, who describes pre-trade credit checks as arguably the most important factor in the longevity of prime-of-prime businesses that want to accommodate participants seeking access to multiple venues.
“If a client is only trading on one venue, we rely on that venue’s credit system to control net open position,” he explains. “For clients that want to trade across multiple venues, we have pre-trade risk control options that enable consumption of market data from multiple sources.”
Stater Global Markets
Given the post-trade/prime broker construct, where risk management has generally been controlled via net open position, Ramy Soliman, CEO of Stater Global Markets, another prime-of-prime provider, observes that pre-trade risk checks will need to be amended to fit the prime-of-prime workflow.
Peter Plester, head of prime brokerage at Saxo, notes that pre-trade risk technology has become far less intrusive and says the ability to safely over-allocate credit for a client with liquidity providers or ECNs – whilst maintaining a net open position limit centrally – is of great benefit.
So where does the market go from here? According to Plester, there are many value-added services available via prime-of-primes that can make their services very competitive when compared with a traditional prime broker.
|Peter Plester, Saxo|
“For example, liquidity optimization and connectivity services in multiple data centres can help clients reduce costs and improve profitability, and we can also bundle in features such as MT4 bridges,” he says.
IS Prime’s Sitlani reckons the fact that the product range is limited plays out well for those prime-of-prime providers that can offer a highly focused service.
“Providing a tailor-made, targeted and robust range of solutions is a major challenge, for which providers need to make significant investment in technology and quantitative skills,” he says.
“The art is to be able to efficiently marry up liquidity with client flow and this can only be done with the most advanced and sophisticated execution optimization engines and Wall Street-grade analytics.”
Fluent Trade Technologies’ Neihous agrees, suggesting that to remain relevant and competitive, prime-of-prime providers need to expand the scope of their services beyond credit into areas such as research and clearing.
|Raj Sitlani, IS Prime|
The future will be about providing execution and trading support services with full mobile functionality and analysis, using big data technology to provide clients with live, bespoke analysis of their liquidity streams, as well as reporting of other aspects such as credit usage, capital efficiencies and execution costs.
That is the view of Invast Global’s White, who reckons the top-tier prime-of-primes will become more like the top-tier prime brokers.
“They won’t hold proprietary risk in conflict with their clients,” he says. “They will provide full transparency through to the underlying exchange or OTC venue, or underlying OTC market maker. No one wants to deal with a provider who might be conflicted by the fact that they internalize flow or anonymize liquidity.”
Fred Allatt, executive director of FX at execution, clearing and advisory firm INTL FCStone, says there has been a lot of discussion of how the prime-of-prime space is growing and becoming more competitive.
“However, just as the banks entered and then left the market in the past, I would expect other providers to exit the prime-of-prime space over the next 12 to 24 months,” he concludes.