Aggregated pricing streams are preferable to single bank lines for most FX trading clients.
Non-bank price-makers have become more influential during the past few years and for most clients a prime-of-prime (PoP) broker is the only way to get access to this important liquidity source.
Stater Global Markets’ June 3 announcement confirming it was ceasing its PoP offering referred to the difficulties of competing with larger rivals, even for a business with a substantial client base and a strong management team.
While the firm says its decision was prompted by the refusal of investor SBL Holdings to put any more money into the business, providers are coming under increasing pressure from clients who want to know they are getting better access to liquidity.
According to IS Prime managing partner Jonathan Brewer, many PoPs actively market themselves as “true prime of prime”, positioning themselves solely as a credit intermediary that gives a client access directly to tier-1 liquidity and even the chance to communicate directly with liquidity providers.
“This is essentially a watered-down tier-1 prime broker service at a higher cost, meaning that every one of these clients would go to a tier-1 prime broker if they were able to and cut out the middle man,” he says.
“There is no ‘value-add’ to a service that is purely renting the prime of prime’s balance sheet and charging a premium.”
Clients accessing a genuine PoP set-up should have much more control over the liquidity they face and therefore have access to liquidity that is better than standard margin FX trading.
However, any assessment of the benefits of using a PoP for clients trading spot FX is complicated by the range of different capital and credit agreements in place with the broker.
“There is a tendency in the market for prime of prime to not quite be what it says on the tin, which means the client is not necessarily getting the service they want and may in fact have more of a standard margined FX solution,” says Jason Hughes, global head of sales at FX broker ADSS.
“In a true prime-of-prime scenario, a client should be able to connect to the liquidity pool they want rather than that defined by their broker.”
In light of this, it is hardly surprising that some brokers believe the market would benefit from greater transparency and better understanding of how PoPs operate.
It is in the interests of some brokers to maintain the ambiguity of what exactly constitutes a PoP provider, says FXCM’s head of FX prime brokerage Justin Boulton.
“This way, they can keep calling themselves a prime of prime when in reality they are just offering liquidity and execution services,” he says.
“A real prime-of-prime broker is a neutral intermediary that offers a pure clearing solution with direct market access – it does not operate a liquidity pool of its own.”
From a technology perspective, the PoP market has benefited from a focus on low-latency connectivity and pre-trade risk management.
Credit availability is distributed to the execution venues for ‘at-trade’ credit checking – reducing any latency induced by routing execution messages through pre-trade credit checks – and clients with relatively small collateral balances can now access multiple execution venues under a single umbrella limit with less risk of rogue algos breaching the limit.
However, Noel Singh, head of eFX business development at Sucden Financial, suggests the post-trade segment has been neglected since the emergence of NetLink, a post-trade system for prime and retail brokers, with spot trades still taking three days to settle.
Brokers that have traditionally operated in the retail space are now diversifying their offering to target institutional clients, although many of the clients leaving bank prime brokers will still require a strong balance sheet when choosing their new provider.
“I sense a move within the higher echelon of providers towards a more traditional prime model, where liquidity providers are disclosed or non-bank liquidity providers reach clients not supported by prime brokers through prime-of-prime credit intermediation services – a more pure prime model than the traditional anonymous aggregated model,” says Singh.
Gavin White, CEO at Invast Global, suggests PoPs that can achieve critical mass will attract interest from acquisitive banks and spark a wave of consolidation.
“The investment banks will likely be major investors in boutique firms,” he concludes.
“They know intimately how profitable a segment it can be and they also know that they are being forced to offload many clients who are capable of generating huge value.”