Double standards: Standard Chartered insists on massive capital and liquidity charges, yet fails to meet its own required capital stipulations

Tier 1 banks are widely recognized as the true source of market access and distribution of FX liquidity to the OTC derivatives and electronic trading business worldwide.

Not to put too fine a point on it, just a handful of such banks that specialize and concentrate their efforts toward the interbank electronic trading business, largely operating from Central London.

Over the past few months, the giants of the electronic trading business have demonstrated their increased focus on the interbank FX market, that being very much their core business as it is a vast revenue generator and has far less operational cost than retail banking and a much greater return.

Just two weeks ago, Barclays, the world’s third largest interbank FX dealer by market share, completed its absolute divestment from European branch banking, selling its remaining 74 branches in France to AnaCap Financial Partners. This means a complete concentration – and domination – in the interbank FX markets for Barclays BARX platform, as last look execution lives on and becomes even more of a core business activity.

Today, Standard Chartered has begun to follow suit, ditching its entire retail banking business in Thailand to Tisco Bank and AllWays.

Standard Chartered is the twelvth largest interbank FX dealer by market share, sitting between Societe Generale and Morgan Stanley, with 2.4% of the entire global market.

Its increasing divestment from traditional retail banking demonstrates once again the lack of viability of wood-paneled branch banking and the absolute viability of one centralized office in London that powers the world’s electronic markets.

No real estate costs, no operational and procurement costs, no massive payroll and no having to weigh all of that logistical and operational legacy business up against a selection of tiny revenues from high street borrowers and current account holders.

Ordinarily, this would bode well for good business sense, however in the case of Standard Chartered’s retraction from the retail banking sector and its stronghold in the Tier 1 liquidity sector, double standards apply.

Last month, Standard Chartered met all its hurdle rates in the Bank of England’s stress test but failed to reach the minimum capital requirement.

What would happen to an OTC prime of prime that had a relationship with Standard Chartered if it even so much as dipped below the contractual capital requirements, let alone those stipulated by any regulatory authority?

The bank would cut the liquidity feed, that’s what.

Bearing in mind that just five years ago, it was possible to maintain a prime brokerage relationship with most Tier 1 banks in London with a capitalization of $5 million, however nowadays it has risen to between $50 and $100 million, hence if an auditor from a bank makes a visit to an OTC derivatives institutional provider’s premises and checks the balance sheets, finds there is less than what it considers to be an acceptable amount of net capital, the bank would remove the relationship or place strict restrictions on how many trades could be processed and at what value.

Perhaps rather an added potential moot point is that from 2012, Standard Chartered has applied a liquidity charge in which the bank applies a levy if tehre is a margin shortfall.

Standard Chartered states in its terms and conditions that it may be required to fund a margin requirement shortfall in circumstances where there is insufficient client-funded collateral available at the time the CCP requires a margin requirement to be met.

The bank may apply a liquidity charge in respect of the margin shortfall paid by Standard Chartered to a central counterparty, which would accrue at a rate that is the aggregate of Standard Chartered’s cost of funds plus 200 basis points (or such lower rate as the parties may agree). The bank’s terms also highlight that it may charge a capital charge reflecting its costs of funds for the capital requirement of a client’s clearing account.

Thus, due to the regulatory authorities for non-bank entites and banks being two different organizations in the United Kingdom, the FCA being responsible for creating regulatory guidelines for non-bank participants whereas the Bank of England’s Prudental Regulatory Authority is responsible banks, it is entirely legitimate that a bank may dip below its capital requirements, yet not allow its own commercial customers to continue to operate if a threshold stipulated by said bank (not the regulator!) is crossed.

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 spoke to Natallia Hunik, Global Head of Sales at Advanced Markets & Fortex during a meeting in Boston, Massachusetts, with regard to 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.

In markets outside of North America, firms such as XTX and Citadel Securities are less commonly used, however they are a very significant force in terms of efficient execution, that is if the potential non-fill is not of great concern.

Meeting with Saxo Bank’s Head of FX Prime Brokerage, Peter Plester in London recently, this subject was indeed a very large matter of importance.

“Because clients were used to having direct relationships with liquidity providers they could have lost a lot of feedback and data but they still get it because we do it for them whereas if a broker went to a prime of prime that didn’t provide that, it may be that the broker begins to feel devoid of information” – Peter Plester, Head of FX Prime Brokerage, Saxo Bank

Mr. Plester explained that there is ambiguity among many brokerage firms about how this relationship is supposed to be structured. “We have been providing this specific prime of prime service for 4 years now” he said.

FinanceFeeds then raised the subject of the fact that it is becoming harder to become a prime of prime, the banks require far higher capital bases. Just a few years ago, $5 million would have got a prime brokerage relationship with a bank, now it is between $50 million to $100 million, and in many cases despite the capital being high enough, banks will still not provide credit.
Mr. Plester answered “Many existing brokerage firms which are not primes have already got a feed, and have begun farming it out, however in doing that, they must establish and structure themselves in the way a prime of prime would, not just put out a feed. They would need to put out the service that a prime of prime offers, but work within the required agreements, which is very challenging.”This lack of access to traditional prime brokers has led to a prime of prime explosion this year.

“Some of our clients put between $20 million and $40 million with us, and I wouldn’t be surprised if some prime of prime names themselves have less capital than even that. If you have a client with that amount, and it is 4 times the capital of the prime or prime then there is no capital there to make the client whole. Looking at MF Global and what happened in the past, – it always pays to make sure that a prime of prime is well capitalized. It is actually largely their capital that you would have some recourse to and these days there are not many around with a decent amount of capital” – Peter Plester, Head of FX Prime Brokerage, Saxo Bank

Indeed, these are very valid matters and will continue to mark out companies such as Saxo Bank as absolutely the most knowledgeable and astute providers of prime of prime liquidity in this industry, the banks and electronic communication networks providing a multi-product, multi-faceted combination of aggregated non bank and bank liquidity without such issues arising.

The matter still remains, however – banks are continuing to divest from retail operations, concentrate on electronic trading, yet fall below their capital adequacy requirements stipulated by regulators and central banks, yet force OTC derivatives firms to face charges if they do not continue to meet increasingly stringent, in-house devised capitalization requirements.

Basically, you wear one type of shoe if you are a bank, and a different type of shoe if you are absolutely anyone else.