When does a prime brokerage or vendor become a retail FX firm? FinanceFeeds investigates

The complex heirarchy that forms the structure from within which retail FX and electronic trading companies operate has made a very significant change over recent years, evolving from the original closed-system MetaTrader 4 based order execution protocol in the middle of the first decade of this Millenium, in which trades were not transferred to a live market, but the ‘market’ was made by the dealing desk within a brokerage, and fixed-spread currency trading was provided.

Those days are long gone, and, although the b-book is alive and well, and here to stay, the entire trading infrastructure within the vast majority of retail firms, large or small, now emulates that of the non-bank institutional trading sector in that the trading platform, whether MetaTrader 4, a different third party platform or a proprietary system, is connected via a FIX API or liquidity bridge to an aggregator, usually a specialist prime brokerage or solutions vendor, which then distributes orders to the banks or internalizes them according to risk management policy.

This of course was a very welcome direction by regulators, traders and retail companies alike, and gave rise to a large expansion of providers which serve liquidity and technology to retail firms, which themselves could elevate their status in the e-FX world by emulating the large institutional companies and providing a professional environment to retail clients.

Whilst this is indeed exactly the kind of large-scale advancement that puts our industry at the very top of the forward-thinking, rapidly developing fintech industry, something which is often overlooked is the fine line that can be drawn when a vendor, liquidity provider, prime brokerage or broker solutions company, all of whose clients are retail brokerages, begins to operate in the retail market itself.

Whether this is a conflict of interest or not is perhaps a moot point, however there are several examples of large wholesale and prime liquidity providers, as well as vendors, competing for the same retail market share as their own clients.

Perhaps the most interesting example of this, and possibly one of the most overlooked, is that of the relationship between NADEX, one of Chicago’s two dedicated binary options exchanges that are regulated by the National Futures Association (NFA), and its members, as well as those who execute trades on the exchange.

When is an exchange not really an exchange?

Among the two dedicated binary options exchanges via which the NFA insists that all binary options order flow must be conducted as OTC binary options trading is illegal in the United States, Cantor Futures Exchange differs significantly in its corporate structure to NADEX (an acronym for North American Derivatives Exchange).

NADEX is owned and operated by British electronic trading, CFD and FX firm IG Group Holdings plc (LON:IGG) and according to extensive research into this by FinanceFeeds, the counterparty to all trades executed via NADEX is IG Group which is the sole supplier of  market liquidity and pricing to NADEX.

Such a structure brings into question whether NADEX is really an exchange in the way that the NFA designates it, or whether it is a market maker in its own right and ultimately whether there is a difference between this system and an OTC system with a commercial counterparty.

The rationale behind the NFA’s ruling that all binary options in the US should be traded via exchanges was to remove the “me versus the house” element that exists among OTC providers, and place the binary options provider and traders on the same level, with market prices being provided via an exchange to both broker and trader.

Prime brokerage services….. from a retail broker

In 2014, FxPro, one of the most successful retail brokerages to come from the global FX industry hub that is Cyprus, launched an institutional prime-of-prime service which intended to leverage the company’s pool of tier 1, multi-stream liquidity and provide it to institutional businesses.

Operating from within the center of institutional FX, London, the division set itself in place as a prime brokerage which is operated by one of the large retail firms that has presence across many regions of the world.

At the time of launch, Charalambos Psimolophitis, CEO of FxPro said

“For small to medium sized institutions that are looking to save costs on their spot FX execution, FxPro Prime not only offers this, but it is also a solution that removes the need to establish relationships with one or more top tier banks where credit facilities have been contracting. We are very excited about entering the prime-of-prime market with our outstanding liquidity and low cost offering as we feel it is a part of the FX industry that has considerable growth potential.”

Does this mean that such institutions become white label partners of FxPro by default, and instead of having their own aggregated liquidity feed, are taking it from a retail brokerage’s dealing desk?

Indeed, a long standing industry concern has been over the ability of white labels of other brokerages to conduct their own liquidity and trade execution decisions. A white label partner may be able to advertise to clients that it offers a direct market access agency model, however because all of the order flow is handled by the host brokerage, it is likely that the b-book activity will be conducted one level up and really the white label partner is an introducing broker rather than a brokerage in its own right, something with regard to which many retail customers remain unaware.

B2B, or B2B and B2C?

This then moves us onto the question as to how many ‘prime brokerages’ that are structured to take only retail FX brokerages as commercial customers and provide them with liquidity, actually take direct retail customers onboard, thus competing with their own customers.

Back in 2013, LMAX Exchange stated that it was in the process of ensuring that all clients with smaller account balances were handled by broker-partners (white labels, liquidity takers) and that larger accounts would be handled directly, following, in effect, a similar vein.

At the end of last year, broker technology provider Leverate ventured into the retail arena with LegacyFX, a newly founded FX brokerage in Cyprus, which was established using Leverate technology and funding from some of the shareholders of Leverate.

The company’s CEO is Mariano Obludzyner, who now heads LegacyFX after a number of years at Leverate as Head of Customer Relations. The company uses Leverate Financial Services’ CIF license in Cyprus.

At the time of launch, Nicc Lewis, Chief Marketing Officer at Leverate explained to FinanceFeeds “We view LegacyFX as we view any client. There will always be suspicions, that is just human nature. LegacyFX will need to stand on its own merits. One of the benefits our clients will get is the results of close cooperation on developing some of our products like SIRIXActive and having a test case for success.”

What is clear is that the retail client is the end target audience for all firms in the retail-orientated sector of the industry, and therefore as the interest in acquiring retail customers swells among liquidity firms and prime brokerages in the retail sector, a byproduct to look toward may be yet further consolidation among retail participants across all levels of the aforementioned hierarchy.