Nick Pratt

What PoPs to partner with – Exploring the nature of true Prime of Prime models in FXPB

March 2022 in Brokerage Operations

The prime of prime (PoP) model has increased in popularity in FX prime broking but as it has grown in popularity, the definition of a PoP has become stretched. Nicholas Pratt asks three providers for their opinions on what constitutes a genuine PoP offering.

It is only natural that as business models develop over time, the definition of that model becomes stretched. Hybrid offerings emerge and this can sometimes lead to confusion for market participants. This is especially true when that model has itself evolved from another more established offering.

In the FX broking world, a prime of prime (PoP) is generally considered to be a firm that offers retail brokers access to the trading liquidity of bigger banks. It acts as an intermediary for those institutions that cannot meet the stringent capital, credit and legal criteria mandated by tier 1 prime brokers.

“Firms are recognizing the benefits of dealing with a reputable firm, one with longevity in the market, a genuine PB relationship and a strong balance sheet.”

Michael Cairns

Tier 1 relationships

For Michael Cairns, the chief operating officer of Advanced Markets, having a tier 1 broker relationship is therefore the most important distinction between various PoP offerings. “Advanced Markets has longstanding Prime Broker (PB) relationships with both UBS and Standard Chartered Bank, but there are PoPs out there who do not have a bank PB but instead have a credit agreement in place with another broker who does, therefore they are one step removed from being a true PoP.”

Another distinction to bear in mind is the organisation’s business model in terms of risk, says Cairns. “Does the PoP operate an agency model where all orders are sent directly to the market for execution (A Book), or alternatively, do they warehouse risk, taking the other side of the client’s trade (B Book), or a combination of both (A Book and B Book)?”

Liquidity management is a key factor for any firm operating in the PoP space, says Cairns. Another critical attribute is unwavering adherence to mandated regulatory requirements. This includes the implementation of stringent anti-money laundering and compliance processes and the thorough vetting of potential clients.

Firms should also be experienced when it comes to the risks associated with the provision of leverage, says Cairns. A conservative approach (realistic margin rates) tends to indicate a more institutional, direct market access (DMA) business model such as that offered by Advanced Markets itself.

While the core traits of a genuine PoP offering have changed little, developments in technology have helped PoPs to broaden their propositions. “The removal of latency in the trade process is essential and therefore cutting-edge quote and trade APIs are an essential requirement for any PoP offering along with a robust technology infrastructure and the global location of trade servers,” says Cairns. “The ability to be innovative when it comes to satisfying the varied needs of clients is also key and the provision of ad hoc tools to automate processes aids scalability across the board.”

A true PoP should also have the ability to provide its clients with the necessary tools to run an efficient business

In terms of assets themselves, a PoP should be able to facilitate a multi-asset offering to include FX, Metals, Energies, CFDs, Equities and Futures to name the most requested and that would involve being able to handle the various trading, pricing and settlement nuances associated with each, says Cairns. A true PoP should also have the ability to provide its clients with the necessary tools to run an efficient business and, post-trade, have systems in place to ensure the smooth transmission and settlement of trades at the PB level, adds Cairns.

“Aside from reliable technology, many firms, specifically those operating hybrid B Book / A Book models, require various levels of assistance when it comes to risk management, client analysis and overall business metrics,” says Cairns.

“Lastly, many retail brokers seek knowledge, especially in-depth analysis of their own client base. Metrics surrounding trading history and style, instruments traded, profitability and even market impact of flow, can be developed on a client-specific basis thus aiding decision making at the broker level.”

Cairns believes that the current market conditions have only strengthened the case for true PoP providers. “Declining market volatility in spot FX markets, due mainly to the low interest rate environment of the past few years, has created a demand for multi-asset trading and has led to a migration towards the few true PoPs who can handle multiple products due to their innovation, longstanding market relationships and nimble, scalable infrastructure,” he says.

“Also, an increase in regulatory oversight, new regulations and the underlying demand for transaction transparency, have all driven business to true PoP providers. Firms are recognizing the benefits of dealing with a reputable firm, one with longevity in the market, a genuine PB relationship and a strong balance sheet. Markets can be extremely difficult to navigate, especially for a novice, so a helping hand from an experienced and reliable PoP is a strong factor to consider. Add reputation, market and technical expertise, and clean regulatory history, to the mix and the playing field of potential partners shrinks dramatically,” states Cairns.

Multi-asset class offerings

While there are many differentiators among PoPs, the most important are product, capacity, support, and technology, says James Alexander, chief commercial officer at Invast Global. As the market has become more competitive, price has become less of a differentiator, while the ability to provide a broad, multi-asset class offering has become the central pillar of any PoP solution, he says.

Having a flexible approach to pricing, both in the sense of curated liquidity feeds and commercial terms, is essential

“The recent turmoil in Ukraine has generated volatility across commodities markets. Interest in oil, gold and natural gas as well as some of the soft commodities like wheat and lumber has increased. After years of a near unbroken ‘risk-on’ approach to equity markets, commodity markets are in sharp relief and any PoP that does not provide access to all relevant markets will struggle to fully support the trading needs of their client base,” says Alexander.

Capacity to extend credit and net open positions is also a significant differentiator, says Alexander. “It is this area that has been exacerbated in the wake of the Archegos Capital Management collapse and the tightening of risk conditions across the street for tier 1 prime brokers. Industry stratification is now playing out. Larger PoPs will continue to move into an almost prime broker like role while some of the smaller participants in the sector are now struggling to meet the credit/clearing needs of their customers.”

Client support is an obvious but crucial consideration and one that is often neglected, says Alexander. “The proliferation of high quality and timely data has helped break down any actual or perceived trust gap between PoP and clients. PoPs that are able to then take this data and add value via insight and optimisation will invariably maintain relationships over a much longer time horizon. Relationships matter now more than ever.”

Client needs are rarely consistent. Having a flexible approach to pricing, both in the sense of curated liquidity feeds and commercial terms, is essential. The demand for adequate credit/NOP is consistent currently. Access to meaningful facilities that allow clients to scale their business is critical.

“The proliferation of high quality and timely data has helped break down any actual or perceived trust gap between PoP and clients.”

James Alexander

Technology remains the area of fastest evolution and one that underpins the core components of a PoP offering, pricing and execution, says Alexander. “Low latency price formation in OTC products is a base requirement. As LPs, ECNs and other venues increase their speed of price formation, the technologies offered by PoPs must keep pace. With more processing of quotes and orders comes more load and a highly resilient/redundant set-up has never been more critical.”

Total cost of trade data and accompanying analysis is an area of interest, says Alexander. “These near real-time data sets have increased in importance over the last few years and form a key part of the relationship between a true PoP and their clients. Having meaningful and timely data to add context to automated liquidity workflows servers builds trust between the PoP and the client and allows for pricing and execution optimisations to take place in far shorter feedback loops.”

Another area of differentiation for PoPs is the provision of post-trade and analytical services. Brokers and funds in particular, place ever more weight on pre and post trade support, which has increased the need for clear and accurate total cost of trade analysis, says Alexander.

“Allowing clients to understand the impact their trading has in the primary market is a two-sided analysis. On one hand, there is the client execution strategy and on the other, the liquidity provider’s own performance. PoPs are uniquely placed to engage both parties to advocate for an optimal outcome. Some PoP are very active in this process, others, less so. Being able to clearly demonstrate the dollar cost value of market impact is critical for our clients in maximising value capture.”

The current trading and market environment has expanded client demand for genuine PoP providers, says Alexander. “The prime of prime landscape has grown exponentially over the past few years across all asset classes. The pandemic saw a new wave of retail investors enter the marketstrengthening demand across retail brokers and PoPs. Increasingly restricted access to credit has benefited those prime of primes with access to ample credit. The same extends to liquidity, established PoPs with well diversified client flows can leverage their network of underlying liquidity providers to provide a level of consistently aggressive pricing.”

With tightening risk conditions from prime broker networks, a true pop would be able to facilitate efficiencies for their clients’ exposures, says Alexander. “PoPs that can support give ups to various tier 1 prime broker venues, are well positioned to offer clients far more efficient access to the credit within their existing prime broker panel. Should a client who has access to liquidity from one venue wish to trade on the price of another PoP, being able to efficiently manage those positions between a Tier 1 prime broker and your prime of prime is crucial.”

Ultimately, the choice of PoP for FX participants comes down to a mix of the simple and complex factors, says Alexander. “As price is less of a differentiator, reputable PoPs provide a variety of execution metrics prior to integration so clients have a benchmark for comparison. PoPs play a critical part of the success of their clients and a PoP provides service and genuinely wants to see their clients’ businesses grow may just be worth a few dollars per million.”

Another area of differentiation for PoPs is the provision of post-trade and analytical services

Direct market access

According to Justin Boulton, head of FX prime brokerage at FXCM, there are numerous differentiators between PoP offerings including access to market, speed of onboarding, service levels and leverage. The approach to liquidity is also an important distinction, says Boulton. “There is no need for liquidity management when delivering a genuine PoP service as the prime broker should not be involved in the trade flow. Instead, it should be providing direct market access to as many venues and counterparties as possible.”

“Clients are looking for a quick, professional and proactive service with as much access to institutional venues and counterparties as possible.”

Justin Boulton

Additional attributes are risk management and technology, says Boulton. “Some PoPs insist on a pre-trade credit check on all clients which not only protects their business, but also allows enables clients to trade under a single net open position (NOP) with no credit ‘log-jams’. They also focus on reliable and proven technology, such as robust pre- and post-trade technology with transaction cost analysis, aggregation and distribution where required, as well as rapid onboarding.”
The factors that created the PoP market in the first place, such as tightening credit conditions, have become more conspicuous in the current trading environment, further strengthening the proposition of true PoP providers, says Boulton. “Tier one prime brokers are being more selective in terms of the institutions they work with. They want multi-asset clients, not just those with spot FX needs. Following the recent Archegos collapse, they have also tightened existing lending terms and in some cases, terminated access for small to middle sized non-banking financial institutions to minimise the credit risk they were exposed to. This means there are more institutions with significant volume looking for alternatives to tier one prime brokers,” he says. “New and better technology means that these firms can continue to receive the same quality of service from PoPs with no material impact on their trading. This makes PoP, when done properly, a more attractive offering to a broader client base.”

Ultimately, when it comes to the factors influencing market participants’ choice of PoPs, the access to tier 1 liquidity remains at the forefront, says Boulton. “Clients are looking for a quick, professional and proactive service with as much access to institutional venues and counterparties as possible. The best PoP solutions replicate tier one prime brokerage relationships by offering just this, with pure direct market access and the ability to clear their clients’ trades. They are also looking for an extremely quick and frictionless onboarding process, and for PoPs to complete know your customer (KYC) and all other checks within a matter of weeks, rather than the six to nine months it can take to get onboarded by a tier one prime broker,” he concludes.