It is very important for brokerages to look in great detail at how a prime of prime is structured and how its relationships with brokers, banks and ECNs is vital knowledge to ensure correct execution. Two highly experienced Prime of Prime specialists explain all.
2016 in London is definitely the year of the prime brokerage.
The establishment nestles among the financial giants of the Square Mile, and has done for a substantial period of time – in some cases for decades, however this year, a torrent of newly established prime brokerages and firms offering liquidity has made its way to London.
Hardly surprising, of course, as London is the global centre for Tier 1 bank liquidity provision, as well as for non-bank aggregated liquidity delivered via electronic communication networks such as Thomson Reuters FXall, ICAP’s EBS, or Currenex.
Retail brokerages have never had so much choice with regard to order processing, liquidity management and trade execution methodology.
However, with choice and sophistication comes bamboozlement!
FinanceFeeds today met with Saxo Capital Markets senior executives Lucian Lauerman and Peter Plester at the firm’s Canary Wharf headquarters in Bank Street, a 150 meter stretch of modernity that contains such companies as Thomson Reuters, JP Morgan, Morgan Stanley, all of which look across to Cabot Square where the view includes Citigroup, Barclays, Credit Suisse and HSBC – some of the world’s interbank largest FX dealers by far.
Mr. Lauerman is Head of API Business at Saxo Bank. He is a specialist in Prime Brokerage relationships, with 20 years of experience at senior level in bank and technology firms, at Lloyds Banking Group where he was eProduct Director, as well as senior level positions at technology firms FNX Ltd and GL Trade.
Beginning the discussion by focusing on new types of service that are beginning to be offered in London, Mr. Lauerman had been very keen to point out “the liquidity and collateral issues are arising from the use of prime or prime providers or brokers at the same time.”
“The rationale for using two prime of primes makes sense as a contingency, when one of those is a primary provider and the other one is a secondary provider. However, the reason for using a single prime broker at any given time is to consolidate positions in one place for more efficient use of collateral” said Mr. Lauerman.
Important operational matters to consider
Mr. Lauerman stated “If you lodge $5 million in total, use 5 prime of primes, put $1 mio at each prime and then are long at number 1, and then short at number 2, then long at number 3, you will lose out on netting benefit re your use of collateral, and have a complex issue to manage re ensuring you minimize your funding costs.”
In terms of explaining how Saxo Bank conducts its bank relationships, Mr. Lauerman explained “Because of our balance sheet and our status as a regulated bank, we have stable, decades long relationships with the largest liquidity providers in the market, and are able to effectively evaluate the new entrants to the market. This is a major differentiator.”
This was then picked up by Mr. Plester, Head of FX Prime Brokerage at Saxo Bank, an institutional professional with vast experience, having spent 9 years at Rabobank in London as Head of FX Prime Brokerage between 2005 and 2014 before joining Saxo Bank, preceded by 12 years on bank trading desks.
Mr. Plester explained “We are focused on adding value for our clients; from helping them access liquidity, to optimising collateral to reducing risk.”
“This is a value added service” he said. Mr. Lauerman then explained it in detail.
“This is something that we implemented within our own market making business which was established in 1992” said Mr. Lauerman.
“We have designed a series of tools to optimize our flow to the market and we use that technology to benefit our clients. We are able to show them what their flow looks like and how the liquidity providers that they are accessing view their flow. We have regular conversations and understand what metrics the sources of liqudity use to evaluate flow and we have built similar reporting and analysis ourselves so we can show clients how their flow will be viewed and handled by liquidity providers” – Lucian Lauerman, Head of API Business, Saxo Bank
“We work closely with clients to make sure their liquidity access is sustainable. This is not alchemy, it is about creating an environment where clients have reliable and sustainable access to liquidity” he said.
Mr. Plester then explained “If a client was to develop those tools internally, there would be a lot of cost and resources and the client would spend a lot of time talking to several liquidity providers. By outsourcing that to us, we save them time and money.”
“Because clients were used to having direct relationships with liquidity providers they could have lost a lot of feedback and data but they still get it because we do it for them whereas if a broker went to a prime of prime that didn’t provide that, it may be that the broker begins to feel devoid of information” – Peter Plester, Head of FX Prime Brokerage, Saxo Bank
Mr. Plester explained that there is ambiguity among many brokerage firms about how this relationship is supposed to be structured. “We have been providing this specific prime of prime service for 4 years now” he said.
FinanceFeeds then raised the subject of the fact that it is becoming harder to become a prime of prime, the banks require far higher capital bases. Just a few years ago, $5 million would have got a prime brokerage relationship with a bank, now it is between $50 million to $100 million, and in many cases despite the capital being high enough, banks will still not provide credit.
This lack of access to traditional prime brokers has led to a prime of prime explosion this year.
Mr. Plester answered “Many existing brokerage firms which are not primes have already got a feed, and have begun farming it out, however in doing that, they must establish and structure themselves in the way a prime of prime would, not just put out a feed. They would need to put out the service that a prime of prime offers, but work within the required agreements, which is very challenging.”
“Some of our clients put between $20 million and $40 million with us, and I wouldn’t be surprised if some prime of prime names themselves have less capital than even that. If you have a client with that amount, and it is 4 times the capital of the prime or prime then there is no capital there to make the client whole. Looking at MF Global and what happened in the past, – it always pays to make sure that a prime of prime is well capitalized. It is actually largely their capital that you would have some recourse to and these days there are not many around with a decent amount of capital” – Peter Plester, Head of FX Prime Brokerage, Saxo Bank