London becoming an epicenter for new Prime of Prime innovation – Exclusive live report

2016 began with an awakening of what had until this year been something of a sleeping giant.

For the last few years, many retail FX brokerages have remained unconcerned with the complexities of the technological and business relationships that are instrumental to the delivery of high quality market liquidity at all times, largely because until recently, the top end of the chain, the banks, had extended credit to prime of prime brokerages without adieu.

Suddenly, the combination of events that ensued during last year, beginning in January 2015 with the Swiss National Bank’s decision to remove the 1.20 peg on the EURCHF pair and culminating in the issuance of annual reports by the major FX dealing banks including Citigroup, Deutsche Bank and Credit Suisse, all of which showed the severity of their performance over the past year, in some cases registering the first annual losses since before the 2008 financial crisis.

This led to a credit crunch, although in this context the term refers to the lack of will that banks now have to extend credit to electronic trading entities, including the prime of primes that have direct relationships with said banks.

Indeed, Citigroup recently published a report stating that according to its research, the extension of credit to non-bank OTC electronic trading entities carries a 56% potential default rate.

Effectively they either will no longer extend credit, or they will request much bigger balance sheets. $250,000 would easily get a Prime 5 years ago, we are now talking about minimum amounts in the $15 million if not $25 million or $100 million in some of the large Primes.

For this reason, 2016 has become a year in which prime of prime services and the connectivity providers that facilitate their link to the live market and to retail brokerages have had to innovate substantially in order to provide better prime of prime relationships and access to best execution for the brokers that use the services.

Joining the fold now is British electronic trading company AFX Capital, which has renamed itself to AFX Group this week, one of the strategic decisions by the company to incorporate specialist divisions into its corporate armoury, one of which is to offer a new liquidity management service.

At the iFXEXPO International 2016 hosted by Conversion Pros, FinanceFeeds spoke to Francois Nembrini, Global Head of Sales & Liquidity Management at Quantic AM, who detailed the company’s evolution into asset management, liquidity distribution and a new incubation program which is designed to uncover and support the world’s best talent.

Mr. Nembrini, who previously spent 12 years at FXCM’s institutional division FXCMPro in London and New York as Managing Director, joined AFX Group in January 2016 to lead this initiative.

Mr. Nembrini explained “The basic concept is that there are less and less customers that have access to prime brokerage at the moment, the institutional pool is overbroked as a result, and the customers that have prime brokerages don’t pay much anymore as there are more solutions available in a smaller customer pool.”

“The bank credit departments won’t take less capitalized businesses” continued Mr. Nembrini.

“The opportunity in the institutional business is then to get into the credit intermediary business,launch a prime of prime service and leverage this prime of prime customer flow to offer unique value to regular give up customers” – Francois Nembrini, AFX Group

“If we bring $100 million a day of unique flow to a bank like BNP, the bank will be more open to allow us to compete with other institutional brokers because a profitable relationship for the bank is already there ” he explained.

The age of decreasing margins!

Mr. Nembrini reflected on how themargins have been driven down, and what the cause of this has been “In the beginning, there were technology firms,clearers, brokers, then the market makers. Everybody was easily making $5+ per m profit. Because customers pay much lower overall fees today, to be able to stay profitable you need to consolidate these activities” he said.

“Ten years ago, it was possible to charge $20 or $30 per million even to large institutions, now it is hard to get even $5 because of the increased competition.”

Out of the 4 elements, technology and brokers have felt the most out of this decrease while clearing fees have stayed stable and for the most have increased. As a result Mr. Nembrini says that there is a great need to have flexible technology at a fixed cost in order to have a scalable business.

Mr. Nembrini explained “Paying technology per million traded render companies uncompetitive because there is no more room for brokerage when one has to consider clearing fees, technology fees and customer expectations ”

What is next?

“Our next step is to attract prime of prime customers” explained Mr. Nembrini. We thought doing incubation for emerging money managers would give us an edge and are implementing this strategy via our new Quantic Lab division, which tests strategies with our own capital before introducing them to our network of financial advisors.”

In terms of corporate structure, the Quantic entity has three facets. Mr. Nembrini detailed them in that “Quantic AM concentrates its efforts on investment management, whereas Quantic Prime focus on delivering institutional execution and clearing services.”

“The third facet is Quantic Lab, which is a strategy incubation program to find people who have good quality strategies that we can help grow using our infrastructure and can introduce to our investors” he said.

“So far, the group has been successful in attracting individuals with portfolios with values between $1 and $5 million, whom are not attractive to private banks as they are too small, but would receive very little return from investment in mainstream banks so therefore they are ready to put small amounts of net worth into alternative investments with average account sizes of $100,000 to $500,000 per investor” said Mr. Nembrini.

In conclusion, he explained “Asset management is a low leverage activity which stabilises our balance sheet versus broker only structures. Self traders have a tendency indeed to leverage themselves a lot while we can hardly manage funds at more than a leverage of 5. In turn this means that we are a more credible counterparty for banks.”