ADS Securities believes that Prime of Prime revolves around credit intermediation

De facto execution models have been called into question this year, largely as a result of the need to innovate at prime of prime level, due to the restrictions being placed on the extension of credit by Tier 1 banks to OTC derivatives firms.

A dichotomy has emerged in which banks are actually bearing down on their core business, that being well-capitalized prime of primes, which are provided with aggregated liquidity from one central office per bank, whereas they are majoring on their cost and resource-hungry retail banking operations which are not major revenue earners, and full of risk.

London has become a prime of prime epicenter recently, with many long-established companies having set up their own prime of prime division, one of which is ADS Securities.

In the summer of this year, FinanceFeeds met with Marco Baggioli, Executive Managing Director of Global Brokerage at ADS Securities in order discuss how, faced with higher capital requirements, higher costs and reduced profitability, some of these Tier 1 banks stopped providing FX-only prime brokerage services and many others re-evaluated their appetite for sub-Tier 1 clients.

In developing the Prime-of-Prime product offering, ADS Securities saw a unique opportunity to leverage both its strong relationships with existing PBs and its high level of capitalization to offer institutions substantial credit facilities to support their prime brokerage needs.

Mr. Baggioli, an expert in institutional trade execution and prime brokerage relationships, estimates that there is a potential credit gap affecting up to $1.3 trillion in terms of average daily volume that needs to be filled, and that the entire method by which OTC firms conduct their business from the relationships with banks, through liquidity and technology providers and prime brokerages, right down to the retail brokerage needs to be examined in order to overcome this matter, reduce the cost and improve the efficiency of prime brokerage relationships.

“The lack of credit will lead to much wider spreads and increased pricing for all, from banks, to hedge funds, international businesses and all FX traders and, at the moment, no one is facing up to the problem” stated Mr. Baggioli.

Today, this dynamic continues and FinanceFeeds has conducted research into how brokers can make sure they are working with a well capitalized Prime, and how primes that have good captial bases can help show strength to brokers at times when banks are reluctant to give them not only credit for trading but also operational bank accounts and client fund holding accounts.

Our understanding is that it has become very much a sellers market and the onus is as much on the counterparties needing to prove they’re good for the credit, rather than grandstanding by the Prime brokers. The smaller ones simply can’t work in the clip sizes they need, or otherwise restrict which prices are made available.

Bearing this in mind, it is important to examine what a prime of prime requires from its client, and what a retail brokerage wants from a PoP broker.

FinanceFeeds today spoke to Louisa Kwok, Head of Prime of Prime at ADS Securities London Ltd: “The shortage of credit is a genuine concern for forex market participants and we’ve seen a rise in prime of prime providers looking to fill that gap. That said, there is no shortage of confusion over what prime of prime really entails—many providers market themselves as “true prime of prime” providers with varying capabilities. Accordingly, it is increasingly difficult for clients to compare ‘apples to apples’ when assessing their options.”

“ADS Securities believes that Prime of Prime revolves around credit intermediation, transparency and giving clients maximum control over managing their flow– akin to traditional prime brokerage. There are important distinctions around disclosed trading at execution vs executing on an anonymous pool vs executing anonymously on a selected pool. This is an important distinction especially for clients with different strategies and flow types, and who are used to receiving better spreads from existing relationships” – Louisa Kwok, Head of Prime of Prime, ADS Securities London

Ms Kwok continued “So, from the client perspective, we find the questions asked concern whether we can build a long-term relationship – can the Prime of Prime provider scale up and pioneer new ways of doing business as the clients’ needs develop and market evolves, particularly in times like these where we’ve entered unchartered territory? Also, our counterparties want to know that their chosen providers are backed by Tier 1 prime brokers and as well as their own supporting balance sheet, providing the very best standards of governance and financial stability.”

“From the Prime of Prime’s perspective, they need to be assured that the counterparty is credit worthy (inclusive of passing required due diligence checks) and understand the clients requirements and their flow. For some prime of prime providers, they will be cautious of unfavourable flow, which will do little to help the PoP’s relationship with its liquidity providers” concluded Ms. Kwok.

Hormoz Amir Faryar, Director, Institutional Sales, ADS Securities LLC then explained to FinanceFeeds “The Prime of Prime market is growing quickly in Europe but the proposition is still a niche one in the MENA territories. We find that because we originally built this solution to run out of London, it gives our clients a huge amount of confidence in the fact we can intermediate efficiently with such a large number of counterparties. The assurance that they can still use their existing relationships really make this a popular service – and one that clients are all too willing to pay for.”

With the Prime of Prime sector being ever more London-centric, these are important matters to consider from both sides of the execution chain.