Don’t get caught out! How to mitigate exposure to volatility by a prime brokerage

Managing a relationship between FX firm and prime brokerage is more than a corporate partnership that requires one firm’s technology or ethos to suit that of the other.

Risk management among prime brokerages is often overlooked, with many retail FX companies concentrating on their sales, marketing and customer retention – itself not the easiest of tasks by any means – and then putting their faith in the prime brokerage that all order flow can be sent with no risk of exposure to their own business.

It is indeed prudent to take a close look at how prime brokerages manage their risk, and as the black swan event caused by the Swiss National Bank’s removal of the 1.20 peg on the EURUSD pair in January this year demonstrated, in some cases the prime brokerage is in a very similar situation in terms of risk management and capital adequacy to the retail FX firms to whom they provide service.

January 15 this year claimed Boston Prime as a casualty, among the litany of retail FX firms that were affected.

The A-book execution model, also known as agency model, was an adaptation by brokers which use MetaTrader 4 from the original B-book model for which MetaTrader 4 was specifically designed and coded.

Via the liquidity bridges available, firms could connect to aggregators and prime brokerages, and then offer agency execution, thinking that this is a good sales feature, and that the prime brokerage would conduct full risk management.

Don’t catch a cold! Internal risk management can be done locally, at broker level

An industry expert who has a clear understanding of how to mitigate this factor is Jeff Wilkins, Managing Director of ThinkLiquidity, a risk management specialist based in Grand Rapids, Michigan, which earlier this year opened an office in London to serve the Square Mile’s highly advanced FX sector.

Mr. Wilkins explained to FinanceFeeds today “Managing risk is not simple by any stretch of the imagination, but it is a critical component to any brokerage.

“Before January 15th, I used to hear the line “we are an agency broker so we can sleep at night” he said.

“Many of the brokers that said this can now also sleep during the day as well since they are out of business. There is an ecosystem between risk, tech and liquidity and my firm manages this ecosystem with extreme precision” continued Mr. Wilkins.

He concluded by explaning” With the explosion in the number of brokers over recent years, my biggest fear is our beloved industry gets an even worse reputation due to mis-management. If you run a broker, take a moment and ask yourself “Do I have the proper risk management and technology in place?” If you cannot say yes with 100% certainty then nothing is more important to your business than solving this immediately.”