Chinese IB joint ventures, the evolution of prime of prime, how to host effectively and why non-bank LPs often only fill 60% of orders. An in-depth discussion with Advanced Markets in Boston, Massachusetts
The first flakes of snow of the New England winter are falling here in Boston, Massachusetts, as the sun sets on 2016, the year of the explosion in the prime brokerage space.
While not regarded as one of the world’s major financial centers, like New York, London or Singapore, Boston is actually home to a sizeable number of financial sector, electronic trading and FinTech thought leaders. Many of these play an instrumental role in our industry in that their reach extends globally and touches to all aspects of this business, ranging from integration and MetaTrader 4 bridge technology to prime of prime services.
The over-reaching, academic and scientific nature of Boston’s demographic is therefore somewhat fitting when considering the future of the ever-evolving and rapidly developing world of electronic trading.
As 2016 begins its final month, it’s good to take a look back over the year but it’s more important to look forward. In that regard, Finance Feeds, today, sits down at the head office of Advanced Markets & Fortex, to speak with their Global Head of Sales, Natallia Hunik, on what developments are likely for the prime of prime sector, as well as for those retail brokers using such services.
Exactly one year ago, in exactly the same location, FinanceFeeds spoke to Advanced Markets and Fortex senior management on new methods of becoming established in what is one of the world’s most important regions for electronic trading – mainland China.
Meeting with Advanced Markets’ and Fortex’s Natallia Hunik, we specifically discussed prime of prime services in China. At that time, FinanceFeeds had conducted a vast amount of research in China, and one dynamic, considered among Chinese firms, to be a potential catalyst in changing the entire framework a year ago, was that the Chinese government, rather than issuing a regulatory license to FX brokers (which will never happen), may begin ensuring that all FX is conducted via banks.
By doing this, the government could control the entire system, and have ownership for all accounts, and retail traders would be forced to trade with the bank that they have their day-to-day bank accounts with. We asked many brokers if they intended to look at hedging their bets and partnering with Chinese banks and most said no.
“We are very well positioned to go that route but, at the moment, we are discussing opportunities with local Chinese exchanges rather than banks. It’s true that the existing exchange platforms may be very old and not at all appealing to the younger trader but, if you are sophisticated enough, then you can partner with the exchanges in order to provide trading facilities while, at the same time, utilizing technology such as ours to give the traders the type of access they desire” said Ms. Hunik at the time.
Today, one year on, a clearer picture has emerged due to continual research from Advanced Markets on this subject.
“Another major trend we are observing in Chinese market is that Chinese brokerages are becoming more sophisticated in what they are demanding from prime brokerages, and are looking forward toward expanding to become B2B providers in their own right, they want to sign up their own white labels.”
FinanceFeeds concurs that indeed, partnering with government-owned institutions for liquidity is a long term exercise that has yet to prove its feasibility, something that Advanced Markets agrees with. “Since government ownership involved, very few non-Chinese entities can engage in any joint ventures or mergers with, or consider any acquisitions of, Chinese institutions” said Ms. Hunik.
“For example, Blackwell Global is a prime of prime in China, and has been expanding its services from retail FX into a firm that offers institutional services within China” she said.
“The demand these days is for more sophisticated tools. There was a time, not so long ago, where Chinese brokers would simply acquire a counterfeit MetaTrader 4 server, and platform, and run a B Book with no market connectivity at all! However, just having a MetaTrader 4 Manager and B Booking flow is no longer enough. As we watch Chinese brokers growing and learning from their own mistakes, we notice a trend developing where they are investing in server hosting within reliable datacenters, predominantly, Equinix’s HK3 datacenter in Hong Kong, for which demand has gone through the roof” she explained.
“The Chinese brokers have finally had enough of second rate hosting providers, as they realize that their entire business connectivity depends on the service that they receive from their provider” – Natallia Hunik, Global Head of Sales, Advanced Markets & Fortex.
In terms of expanding on the importance of connectivity within China, Ms. Hunik continues to maintain that latency is a critical issue for many brokerages. “The traffic censorship in China slows down execution if the hosting is not based in Hong Kong, causing quotes to drop, and orders to be rejected. Brokers need to have a professional top-tier hosting provider.”
FinanceFeeds concurs that internet traffic, including trade execution originating from retail customers or brokers within China, is slower than it would be if hosted internally within China itself, largely due to the government’s systems censoring and filtering data, which, although fully automated, can cause a few milliseconds difference. In this business, especially when Chinese customers and portfolio managers are automating their flow en masse, this factor can be the difference between being able to operate or not.
On that note, Ms. Hunik also concurs that “The use of expert advisers (EAs) is continually prevalent in China, and the user base is now more sophisticated than ever. It is much harder to warehouse that type of automated flow, so brokers need to turn it over to the liquidity provider, making even more of a case for local connectivity and hosting.”
“Now, liquidity can be extended to Chinese Prime of Primes and they, in turn, can downstream it to the smaller brokers which are effectively white labels. This doesn’t mean that most don’t get direct liquidity as, actually, most do” Natallia Hunik, Global Head of Sales, Advanced Markets & Fortex.
XForce, which was launched in January 2016, is Fortex’s system for facilitating liquidity aggregation. At the product launch in Hong Kong, FinanceFeeds gained perspective on its functionality, with Ms. Hunik having explained at the time “It utilizes the following components: the Fortex xBook ECN solution, premium hosting at the Equinix NY4 and HK3 data centers, the Fortex 5 institutional trading platform (for omnibus account management), sophisticated risk-management tools, FIX API access for partners and the Fortex OMX MT4 liquidity bridge. The suite also incorporates a middle and back office solution. ” she explained.
What will 2017 bring for prime brokerage?
“The big thing for Advanced Markets is that there have been more Tier 1 liquidity providers exiting from the market and we expect that access to credit will get even tighter” said Ms. Hunik.
“We are looking to bridge the liquidity gap within more territories globally. In fact, we just recently installed, seasoned industry professional, Nidal Abdel Hadi as FAM Clearing’s (Joint Venture between Advanced Markets and Fortex) Managing Director in Dubai, and we have also expanded operations into Cyprus” she explained.
“The Middle East is a big focus for us and we are expanding services to that region, a part of the world in which there are liquidity providers that have currently only limited access to a Tier 1 prime of prime, one that can provide true direct market access” – Natallia Hunik, Global Head of Sales, Advanced Markets & Fortex.
Access to credit, or the complete lack of it, due to banks having taken a very conservative view on counterparty credit risk, especially when considering providing liquidity to OTC electronic brokerages, has been a major factor this year, something on which FinanceFeeds has gathered detailed and extensive research.
With this in mind, FinanceFeeds asked how brokers can get access to liquidity. Ms. Hunik also understands the critical importance of considering this liquidity “credit crunch”, explaining “We have UBS and RBS as our prime brokers providing credibility, stability, redundancy and flexibility to our liquidity solutions” she said.
“Retail brokers that don’t have access to Tier 1 Prime Brokerage, are posting margin at prime of primes and other liquidity providers, making it tougher to achieve collateral efficiency, especially these days when regulators are requiring more and more funds to be posted as capital and particularly in those jurisdictions where client funds are mandated to be held in the trust. Therefore, in order to mitigate the limited access to credit and achieve better collateral efficiency, brokers need to use a real prime of prime, one that can deliver access to the interbank market under truly institutional conditions and, perhaps, more importantly a prime of prime that can offer additional funds protection (custodial accounts). Counterparty credit risk is a major consideration for banks these days, and they are requiring very high capital bases.” – Natallia Hunik, Global Head of Sales, Advanced Markets & Fortex.
Non-bank a good solution? Yes, but only if you’re ok with a fill rate of only 60%!
“For retail users, the best order execution is by banks with fill rates close to 100%. Compare that to Tier 2 or 3 providers where, from my experience, the typical fill rate is around 60%. Some are better, some are worse, I’ve seen 30% in some cases so they vary but they cannot compete on execution with the banks” said Ms. Hunik.
“A prime of prime has to give each counterparty enough business so that they value the business and provide a deal that is relationship based and, for that reason, a prime of prime that works with a finite number of the world’s best bank providers is typically able to obtain better pricing” she said.
Advanced Markets’ business model is different from most other firms in that all orders are routed directly through to the Tier 1 banks / liquidity providers for execution. No risk is taken in-house.
“I have experience with aggregators that have used both banks and Tier 2 or 3 providers in the past, and at end of month, the prime of prime looks at the analysis and compares execution statistics. Many of the Tier 2 execution statistics were not shining. Yes, in terms of spread, they were outstanding, but that means nothing when they could only execute approximately 60% of all orders”
“Most of the Tier 2 providers’ prices are algo-driven and, when dealing with the retail market, if one of these pulls their price during a market event, retail users will simply not understand why the trade is being rejected – Natallia Hunik, Global Head of Sales, Advanced Markets & Fortex.
Concluding our meeting today, FinanceFeeds touched on how the election of Donald Trump and his pro-business approach may benefit electronic trading.
Ms. Hunik said “The new administration may look to clear up some of the language pertaining to eligible contract participants (ECPs) in the United States and there are talks about repealing some or all of the Dodd Frank legislation. If something like this were to occur, we could well see drastic changes to the industry in this country.”
With regard to the barriers to operation for smaller retail brokerages and Donald Trump’s disdain for any over-regulation that inhibits business to be conducted freely and fairly, and his review of the Dodd-Frank Act, Ms. Hunik said “It is a very gray area that in some cases is not workable. To a small broker, regulatory law, or any impending changes to it, is never crystal clear. Maybe this administration will clear things up and regulation in the US may one day be obtainable for smaller firms” she concluded.
Featured image: Constitution Avenue, Boston, Massachusetts. Copyright FinanceFeeds#advanced markets, #China, #IBs, #metatrader 4, #prime of prime