What’s causing the flight to quality in FX Prime Brokerage?

Nicholas Pratt reviews the changes that have recently taken place in the FX prime brokerage market and what it means for trading firms.

2015 has been a year of seismic change in the FX prime brokerage (FXPB) market, sparked by the events of January when the Swiss National bank (SNB) currency crisis sent the FX markets into a temporary tailspin. It led FX prime brokers to review not only their risk management practices and their client list but their whole business model and to consider whether it was a market in which they should remain. 

For those tier one bank-based prime brokers that did stay in the market, drastic changes were made in term of the clients they were willing to take on. This has had major implications for those firms without a bulging balance sheet. “For the less capitalised clients, having major banks pulling out of the FXPB space has been extremely challenging,” says John Miesner, Head of Global Sales of GTX, an independent FX ECN that offers a prime of prime service and is a subsidiary of Gain Capital. “The ‘return’ that major banks were making on these clients no longer justified the risks associated with a crisis such as the SNB. Therefore, secondary PB services have become an increasingly important gateway back to the Institutional market place for under-capitalised clients.”

These secondary PB services have been provided by prime of prime (PoP) brokers that have stepped in to fill the void left by the withdrawal of the PBs, says Miesner. “Access to the institutional market place is critical to the success of many FX funds. So as the FXPB space contracts, the FX PoP sector continues to grow in importance, providing access to institutional liquidity and spreads.”

Less choice on the PB side has been a particular issue for hedge funds, asset managers and high frequency traders that are now seeking a home among the PoPs in increasing numbers. When it comes to the selection, Miesner says that there are numerous factors involved such as quality of service, leverage levels and cost of capital usage. “Firms are looking for quality prime broking services without the cost.  If fees are too high, profitability suffers greatly, which is why prime of prime solutions such as GTX Direct are of great interest to many former PB clients that have been displaced.”

John Miesner

John Miesner


Significant change

“The FX prime brokerage landscape has changed significantly in the last year,” says Joe Conlan, head of FX sales for INTL FCStone Markets, LLC (IFM), a wholly owned subsidiary of INTL FCStone Inc., a prime broker. Most notably, a lot of bank prime brokers pulled back from the market.

Conlan believes this is the result of three factors. The first and most prominent is the SNB event. “I think a number of banks were operating with the understanding that FX prime brokerage was a low risk business, but the SNB event totally changed that and demonstrated that it is a market with significant risk.” Banks are also going through a lot of regulatory change right now and taking a much more forensic view of individual business lines with the intention of narrowing its focus. And prime brokerage may be one of those businesses that they look to exit.

The final factor is the dwindling margins that prime brokers are faced with where the fees paid by clients are almost equalled by the costs incurred. All in all, it does not make FX prime brokerage an attractive business for many banks. Those that do stay in the market are more selective and quick to reduce unprofitable relationships.  

“It is a great environment for us,” says Conlan. “We are in expansion mode right now and are looking to expand our client base.” Unlike the banks, IFM’s client profile hasn’t changed, says Conlan. “We took the decision some time ago that we would not focus on retail clients. Instead we serve a range of institutional traders, from proprietary trading firms to fund managers, other brokers and regional banks.”

It is the last category, regional and international banks, that have been the most fertile source of new clients for IFM, says Conlan, even though some of them may not have originally intended to be long-term clients of a prime of prime broker. “There are only a handful of banks that can offer a prime brokerage service now and this has left many clients waiting. They have come to us in the meantime, while they wait to be connected to a prime broker.”

Somewhat surprisingly Conlan has not seen many new entrants rush in to fill the void left by the retreat of the top tier banks, especially in the last six months of the year. He puts this down to the fact that it is not such an easy service to properly provide. “To offer the breadth of service that institutional investors require is very challenging. Our initial objective was to offer a prime-like service with all the tools to firms that are no longer able to access a prime broker service.”

IFM offers DMA to all major ECNs and is in the process of implementing Tradair, which will enable a service that will allow clients to access individual banks directly. Conlan says, “Tradair will provide clients with market visibility and trading limit controls so that clients can deal directly with their liquidity providers. To cater to this demand requires some element of risk control and IFM is looking to develop a credit hub through which its prime clients can access single banks and where IFM can act as the credit intermediary. A service like that would give us more risk tools and also connect us closer to the client’s front-end in a risk management sense.” 

Joe Conlan“I think a number of banks were operating with the understanding that FX prime brokerage was a low risk business, but the SNB event totally changed that and demonstrated that it is a market with significant risk.”

Joe Conlan

“I think a number of banks were operating with the understanding that FX prime brokerage was a low risk business, but the SNB event totally changed that and demonstrated that it is a market with significant risk.”


So what criteria should trading firms have when selecting a PoP broker? Registration is the key word for Conlan. “If you’re registered as a swaps dealer, you can provide all the services under one roof – NDFs, swaps, spot and options. If you’re not, it is a limited offering. We registered in both the UK and the US under the FCA and the CFTC.”

Flexibility in the trading platform is also another important quality says Conlan. “We offer clients eight or nine options for trading whereas there are other PoP brokers calling themselves such but only offering one platform. I don’t think that’s a PoP service, it’s a margin trading shop with a proprietary platform.”

So, barring another SNB event this January, will 2016 be as successful for the prime of primes? Conlan says that the momentum is likely to come from macro factors like the Federal Reserve’s much anticipated increase in interest rates and Europe and Japan’s move in the opposite direction via its continued efforts to raise inflation. “I think markets like the PoPs will continue to scale and that’s good for us because it allows us to make more margin and to be more competitive.”

Following the SNB event, a particular problem for FX prime brokers was the creditworthiness of their numerous clients, says Peter Plester, head of FX Prime Brokerage at Saxo Bank. “The large hedge funds and banks with big balance sheets are very creditworthy and were given good lines of credit. But as you go down the pecking order, there are a number of firms that are just trading on margin and if they lose more than they have on account, it is a big problem. So many prime brokers have revisited their policy.”

The top tier of prime brokers – the likes of Citi, Deutsche, Barclays, BNP Paribas – have all raised their balance sheet requirement and increased their fees so it is a double hit for their mid-tier clients, many of which are now struggling to find a prime broker willing to take them on.

This is where the prime of prime (PoP) brokers have emerged to fill this void, says Plester. “In the immediate aftermath of the SNB event, there were several headlines about the losses that banks faced and some mid-tier clients found themselves cut loose. They had to find new prime brokers and they turned to the PoPs.”

FXPB is a market that is definitely not risk-free

FXPB is a market that is definitely not risk-free

The SNB event has also been a catalyst for the consideration of pre-trade risk controls. Before January’s crisis, there were FX brokers giving leverage of 400-1. There were also brokers that failed to recognise the potential risk of the Swiss central bank’s shaky currency peg and ignored the market’s concern. So while there were prime brokers, like Saxo bank, that were reducing their exposure to Swiss currency pairs, others were basing their excessive leverage on historical data ended up in severe trouble. “This has all changed now. Leverage has been reduced, margin has gone up and fees have been increased.”

Risk management

If truth is the first casualty of war, as was the slogan for 1980s Vietnam film Platoon, the first casualties of the SNB event were old risk management practices. “Even though FX prime brokerage is a well-controlled market from a risk perspective, most of the risk control was on a post-trade basis,” says Plester. “When the markets are steady, that approach works fine. But when the market goes crazy and everything is stressed, that is when you find out how good your risk controls are, and many were found to be wanting.”

Pre-trade risk controls are a big priority for Saxo Markets, the Institutional Division of Saxo,Bank Group  says Plester, not least because they help to solve a credit dilemma for prime brokers. “If you have a client with $1m and you offer them 50:1 leverage, there were previously two options for how that credit would be supplied. They would get either get a $50m limit spread over 10 platforms or venues so that the prime broker is better able to control the risk although this is not so good for the customer as they have small limits per venue. The other option is to over-allocate credit and give them say a $50m limit for all the venues which increases the risk for the prime broker but keeps the customers happy.”

A lot of attention has been paid to post-trade risk controls. The big bank-based prime brokers have looked to providers like Traiana to manage post-trade risk via an API, enabling them to either shut down the credit line or control the limit, however not all liquidity venues are connected. Consequenetly few firms have a well connected pre-trade risk control capability. 

Peter Plester“....when the market goes crazy and everything is stressed, that is when you find out how good your risk controls are, and many were found to be wanting.”

Peter Plester

“....when the market goes crazy and everything is stressed, that is when you find out how good your risk controls are, and many were found to be wanting.”

Two years ago Saxo Markets built a system based on pre-trade risk controls and employing aggregation venues like Prime XM, Market Factory and Fluent Trade Technologies with the objective of enabling Saxo to allocate credit more freely. “Before every trade we are able to check the state of credit so that we can allow the client to trade on margin while knowing that they cannot break their credit limit,” says Plester.

It seems an obvious approach to take, especially for any prime broker setting up a new system from scratch, however, says Plester, the problem is that this technology was simply not available up to 18 months ago. And for any prime brokers with much older systems, it is very difficult to add this kind of functionality. Nevertheless, Plester expects this pre-trade risk management to become normal practice in time. “It is the optimal way of doing things and there are a lot of other players now looking at using pre-trade risk controls. The technology will become cheaper to implement. If the move to pre-trade risk controls does not happen naturally, I expect the regulators to step in and look to force the issue.”

For the trading firms that have found themselves moved from big banks to prime of primes, there will be some inevitable changes. The most noticeable will be the lack of direct access to liquidity providers. They will have been used to having direct and disclosed relationships with the banks but now they are no longer trading in their own name. While this may seem like an apparent drop in status, it does offer some operational advantages for trading firms, says Plester. “There are more value-added services, more focus on credit provision, e-trading liquidity optimization and account management. A prime of prime will also centralise everything. They connect to an infrastructure in a data centre and then connect to multiple liquidity providers with one API. They can still see all the various platforms separately and we can also aggregate if they wish to do that. And everything is done at low latency. We do all the work on their behalf so that frees up more time for the client.”

Client considerations

Other than overcoming their sense of humiliation to embrace the operational benefits on offer, what else should firms consider when looking at prime of primes? In Plester’s view there are nine important components to assess. First of all, you need a lot more than a credit line and a price feed to be a prime broker. You need account management, real-time reporting and multiple liquidity provider connections. 

“The first of these is financial strength. It is the ‘prime’ in prime broker. The financial strength is what makes the name credit-worthy and that is why you are trading with them. A second important element is regulation. In today’s market where new rules are being introduced, firms have to ensure that their counterparties are properly regulated. A banking license is a big advantage because a higher regulatory bar has to be met.

Flexibility in the trading platform is an important quality

Flexibility in the trading platform is an important quality

Technology is another watchword of quality. Is the PoP using the latest software? What is the average speed of its trades? Where are its servers located? The more information can be gleaned about its platforms and service providers, the better. Similarly connectivity is a crucial component. You should assess the ease of access to liquidity, the number of different data centres that are used and whether or not they are cross-connected. 

A number of qualities that clients will look for in a PoP may depend on that clients’ profile, says Plester. For example, hedge funds that have an increasingly institutional investor base are facing a growing reporting burden so they will want to know if the PoP has real-time reporting data available for it trading and execution. Some PoPs will even take this a stage further and provide a full reporting service that can be used by hedge funds. Meanwhile, money managers will want to know what options the PoP can provide in the allocation of their trades.

There is also a growing interest in multi-asset trading among firms and they will be looking for a PoP to facilitate this new asset class. If the firm can use a single PoP for trading in multiple instruments, it makes it a much more margin-efficient approach. Transparency is also a quality in increasing demand, particularly when it comes to providing access to ECNs, something that not all PoPs provide. 

The final component is one that is sometimes neglected and that is the speed of on-boarding, says Plester. Given the state of flux in the prime brokerage space and the rife uncertainty, it is vital that clients know exactly how long it will take to get up and running when signing up with a new PB. In some instances this process has taken months. “The process of on-boarding has become much longer because of more stringent regulations and a more cautious approach from prime brokers. Consequently, there is greater scrutiny of the balance sheets. For a firm that has been cut loose by its prime broker, the months spent on-boarding are months in which it is cut off from the market and unable to trade, therefore the on-boarding process should be a big consideration.”

Cyril Tabet“PoPs grant a cost-effective access to PB services, irrespective of the client’s balance sheet. Nowadays, offering multi-asset rapid and hassle-free integration into any IT environment is the key differentiator when selecting a PoP of choice.”

Cyril Tabet

“PoPs grant a cost-effective access to PB services, irrespective of the client’s balance sheet. Nowadays, offering multi-asset rapid and hassle-free integration into any IT environment is the key differentiator when selecting a PoP of choice.”


It was the retail FX trading market that was hit hardest by the SNB event, says Cyril Tabet, Partner & CEO of Cyprus-based JFD Prime, which offers its own FXPB service. “The early days of the retail trading industry, where electronic trading platforms and the internet enabled mass access to the financial market and retail brokers employed a market-making business model, should now be a thing of the past. The latest business and technology transformations have eventually made the impossible possible. Robust bridging, aggregation and clearing technology have finally emerged to fill the gap between the interbank market and popular retail trading platforms, such as the MetaTrader, which were historically designed to operate under B booking conditions, therefore cutting off banks from the retail market and vice-versa.”

Nowadays, Tier1 liquidity pools tend to compensate shortage of interbank liquidity by sourcing abundant retail liquidity matching these two at a lucrative premium, that is why retail trades are now worth billions and what used to be a ‘no’ business has now become ‘the’ business, says Tabet. 

However, the retail trading industry has been shaken up by the SNB event, if not the electronic trading industry as a whole. Top tier PBs have significantly increased their minimum capital requirements thresholds and their service fees, as much as $100 million and $5 per million respectively. Consequently, new Prime of Prime services like JFD Prime with lower thresholds and costs are setting themselves up as the PBs of choice for regulated institutions that may not match a tier one PB’s requirements yet seeks a similar quality of service. 

Tapping into aggregated multi-bank and exchange liquidity pools via the new PBs comes with significant benefits versus connecting to a single or a few select single liquidity providers as per the traditional bank-based PB, says Tabet. “This includes custom liquidity feeds to cater for all types of clients’ trading styles, additional market depth and overall spread stability, lower hedging/trading costs translating into increased revenue margins and most importantly fully optimised cross margining and risk management capabilities. Indeed these are the key benefits of a new PB setup and the reason why a vast majority of retail online brokers and asset managers are looking into deploying such setups.” 

JFD Prime offers all of the above with a few notable additions, says Tabet. For example, it offers access to additional markets like metals, indices, commodities, single stocks and ETFs; it also provides a range of services incorporating choice of preferred LPs, hybrid A and B Book capabilities including a variety of risk management and analysis tools by order types, order direction, ticket sizes, instruments and exposure translating into optimal control and greater revenue margins for the broker, all under a PoP agency-only execution model guaranteeing full post-trade transparency and zero conflict of interest to its retail broker clients. But, most importantly says Tabet, it also understands its clients’ environments, both from a business and IT perspective hence offers a full service supporting multi-asset liquidity provision deployed within a record integration time of less than 48 hours in most instances via FIX API, MT4 Gateway, One Zero Hub, PrimeXM Xcore and more, which is not always the case with a vast majority of so called Prime of Prime offerings. 

Tabet concludes by saying that most PoPs may grant a cost-effective access to PB services, irrespective of the client’s balance sheet, yet nowadays, offering multi-asset, rapid and hassle-free integration into any IT environment should be the key differentiator when selecting a PoP of choice.