The prime broker space has been in flux since the global financial crisis, although currency crises culminating in January’s chaos around the Swiss franc proved the final straw for some providers.
Big bank prime brokers have changed their risk profiles and off-boarded many clients below a certain threshold of assets – usually around $25 million – leaving those clients with limited options for credit intermediation.
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By enlisting a PoP provider, a firm can improve its fee structure and reduce administrative headaches Wayne Roworth, |
The effects of the market shake-out are yet to be fully felt, suggests David Faulkner, head of business development at Fluent Trade Technologies.
“Many clients are still in the process of talking to new prime service providers,” he says. “I believe that process will continue for the remainder of this year and 2016, so I can see growth in the prime-of-prime space continuing to pick up next year.”
PoP providers can sustain their recent growth as long as expansion in active FX trading continues, says Gareth Bowles, head of LMAX prime sales at LMAX Exchange.
“Advantages include faster deployment, flexibility and appetite for risk,” he says. “For example, we can onboard and create a prime-of-prime pricing structure for a client within a week, if required.”
Paul Orford, vice-president of business development at TopFX, refers to the ability of clients looking to trade via a FIX API to do so without a seven- or eight-figure account balance.
However, he notes while providers who offer transparency and excellent execution have a good shot at success, some of the newer names in the market have received criticism after trouble assisting clients with withdrawals.
Paul Jackson, head of sales at CFH Clearing, observes that cost is another attraction, adding: “It has been notoriously difficult for many clients to meet and maintain a prime broker bank’s qualifying criteria in terms of capital adequacy and trading conditions.
“A client would first need to sufficiently meet a bank’s credit rating, demonstrate a strong balance sheet and operational infrastructure whilst meeting all regulatory requirements. If deemed successful, trading conditions such as funding, margins and costs are generally high when compared to a reputable prime-of-prime.”
'Bespoke benefit'
PoP providers are well-positioned for long-term growth as they are far more bespoke than prime broker banks, according to Peter Plester, head of FX prime brokerage at Saxo Bank.
“The top-tier banks have large, global concerns which may shift their focus away from providing prime brokerage services to mid-level clients,” he says.
The FX market has come a long way from the days when only banks intermediated FX flows – the world is becoming progressively unbundled, peer-to-peer and networked and FX is not immune. That is the view of James Sinclair, CEO of MarketFactory, who describes PoPs as an essential enabler.
“Two years ago, a participant’s choice might have been driven solely by whether they had the AUM and credit worthiness for a large prime broker,” he says. “Today it is as much, if not more, driven by the other services they want – prime-of-primes provide execution technology, FX pricing and introductions to their other relationships.”
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James Sinclair, |
Sinclair expects it to become easier for funds to get credit from prime brokers, adding: “The impact of higher capital requirements and other regulatory risks is here to stay, but the tightening due to higher market risk will ease.
“The historical component of risk models is blown out of the water – over time, risk managers have data in the new environment and credit criteria will ease. Irrespective of the changing price of credit, prime-of-prime will continue to grow as, increasingly, it is not just about the credit line.”
According to Fluent’s Faulkner, the net effect of these changes will be the movement of existing business rather than the creation of new brokerage revenue.
“Changing prime service provider can be a laborious process, so the only situation where I could see a client voluntarily taking this step is when they have lost confidence in their prime broker’s commitment to the business,” he says.
Wayne Roworth, co-head of e-FX at Sucden Financial, expects consolidation in the PoP space as access to credit remains open to the exclusive few with a large-enough balance sheet.
“A large provider executing billions of dollars a day and carefully managing their liquidity pool will most likely achieve better spreads than most individual firms, and the advantages extend to prime and platform fees,” he says.
“We are starting to see a trend towards brokers, hedge funds and other prime-of-prime clients choosing to outsource their liquidity management requirements. By enlisting a prime-of-prime provider, a firm can improve its fee structure and reduce administrative headaches.”
Faulkner believes there is considerable potential for offering pre-trade risk control.
“Prime-of-primes are not only taking on risk, but are also embracing pre-trade risk management solutions to control that risk more comprehensively,” he says.
“When you sit at the point of execution, you can control a wider range of risks than credit by preventing risk events from taking place – you can manage activity, behaviour and profit and loss, which protects the provider from risk events and algorithmic glitches as well as reputational risk.”
LMAX’s Bowles suggests reduced appetite for post-trade prime broker business across all client segments means pre-trade risk management will eventually become the norm, while CFH’s Jackson envisages fintech companies entering the market as demand for risk-based tools increases.
