What is causing market makers to label flow from certain brokerages toxic? Investigation

The ongoing interest among retail brokerages in gaining a greater and more detailed understanding of the requirements of the Tier 1 banks has created an extensive discussion during recent months, largely fueled by two scenarios.

The first scenario is that, far from being able to simply plug into a liquidity provider and not think about the processing of orders once they have been sent out of the brokerage via a straight through processing (STP) procedure, brokers now have to consider where the liquidity that is being fed to the liquidity provider is coming from and the risk management system that the supplier to the liquidity provider is bound by.

This has come about due to the great difficulties experienced by liquidity provides in obtaining credit from prime of primes, which in turn have limited their provision due to restrictions in credit by banks, which are concerned about counterparty credit risk.

The second matter is the sheer cost. Effectively, banks 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.

On this basis it is of interest to look at how a combination of risk management solutions from specialists in this particular sector and technology can actually benefit brokerages that want to conduct DMA execution without compromising the trading experience for clients, and still be able to operate within the strict parameters set by Tier 1 banks where they wont extend credit so easily anymore.

In short, a close look at how companies can still provide good execution and mitigate risk of exposure, therefore appeasing banks and prime brokerages.

Today, FinanceFeeds spoke to Fred Gewirtz, a Senior Account Manager at ThinkLiquidity in Grand Rapids, Michigan, who explained “Aggregation is a hot topic in the market today. Brokers locked out of the Prime Brokerage avenue have filled the gap by aggregating margin liquidity. On the surface, this set up can work if the liquidity can be tailored at each provider.”

“In reality, this is rarely the case. This results in brokers hitting the same bank at the top of the liquidity pool multiple times. The market makers do not appreciate this arrangement and will quickly label the flow from that broker toxic.” – Fred Gewirtz, Senior Account Executive, ThinkLiquidity

“The spread improvement from aggregating deteriorates rapidly at same time liquidity relationships are damaged. Brokers without a PB are much better off using a true Prime of Primes and building a strong relationship with the liquidity manager. More often than not, a truly custom tailored feed can be built to suit your brokerage” he explained.

Mr. Gewirtz concluded “Actually Andrew, it is very interesting that we should be discussing this now, as many specialists in our office got into quite a discussion about it today.”

Filling orders and ensuring an effective trading environment is so critical these days, however with the correct set of parameters, accrual of the appropriate knowledge of the structure of the execution channels and each component within, as well as help from those with good relationships, it can be mastered and its sustainability rests on continual innovation.

Photograph: Fred Gewirtz and Justin Biebel of ThinkLiquidity, Hong Kong, January 2016. Copyright FinanceFeeds