What exactly is a prime of prime? Live from iFXEXPO, Limassol, Cyprus

Most certainly, as the first day of the fifth iFXEXPO International here in Limassol, Cyprus progresses, the continued industry discussion centered around how brokerages can connect their ever more demanding client bases to the best quality liquidity and provide best execution in times at which Tier 1 banks are reluctant to extend credit is in full swing.

Natallia Hunik, Global Head of Sales at Advanced Markets and Fortex provided her perspective on how brokers can define a Prime of Prime, explaining

“Since the Swiss National Bank black swan event in January 2015, and even to some extent before that when Rabobank and ABN Amro exited the prime brokerage market, whilst other prime brokerage divisions of banks pulled out, access to prime of prime services became difficult especially via a single aggregated feed for retail brokers.”

“Nowadays, she continued, those who used to work with Tier 1 banks are looking fo access to prime of prime services. There are many terms for what constitutes a prime of prime, but there are certain characteristics that mark out a prime of prime compared to other liquidity providers.

“I was thinking about it and what the formula is for a real prime of prime” she said.

“The first is a business to business prime of prime provider, which has tier 1 prime brokerage relationships, superior technology and operates on a straight through processing model by passing order flow directly to the banks” said Ms. Hunik.

“Why it is important for a retail brokerage that has a contract with a prime of prime brokerage to consider who is behind that particular firm further up the execution chain is that it must be borne in mind the potential conflict of interest” explained Ms. Hunik.

“If a retail firm that takes liquidity from a prime brokerage finds out that a retail firm is providing the liquidity, then there is nothing stopping them opening a retail accont and then your customer becomes your competitor” – Natallia Hunik, Advanced Markets

Working with tier 1 prime brokerages introduces credit and operational efficiency, means that brokerages are able to take charge of credit, and charge their customers accordingly for the services they provide.

“A prime brokerage confirms matching details and inputs back to back trades” explained Ms. Hunik.

One of the reasons that brokerages are becoming less and less able to gain access to Tier 1 prime broekrages becomes very clear when examining the list of requirements.

Risky business?

“Retail brokers that offer 500:1 leverage are considered risky business, so they often have to supply financials detailed accounts of their capital position, go through a strict credit check an pass all the AML reviews even to gain access to recycled liquidity. This process may range from 3 to 4 months to open an account with a standard prime brokerage and can sometimes be much longer” said Ms. Hunik.

“Also if you want to deal with Tier 1 PB you have to find the right technology because you need to aggregate and then get a give up network such as Traiana which can take longer and often is part of the stipulations of working with a tier 1 company” she said.

“A very important component is technology” said Ms. Hunik.

“If you are a Tier 1 prime brokerage and want to work with prime of prime, they usually have some technology which aggregates feeds that they actually provide. As an example, Integral Development Corporation did a survey showing more openness toward A book model back in 2014, which was effectively paving the way for transparency between prime brokerages and their prime of prime providers, as they could always ask their prime of prime where the trades were executed an who by.”

Single liquidity feed, or multiple relationships?

Ms Hunik explained that taking a single liquidity feed saves costs because someone else manages it for you, and covers bank relationships and performance.

“You don’t have to deal with the headaches. if youre paying for prime brokerage and dealing with all the small ticket charges from CLS then the whole process becomes expensive and a lot of work” – Natallia Hunik.

Picking up on a subject that has been discussed among technology vendors here today, Ms. Hunik explained tht often a means of obtaining cheaper access to liquidity is when it is bundled in one offering, and brokers do not have to separate for each vendor.

“If you are a retail broker, then you probably want to distribute into MT4 platform, and prime of primes have usually a partnership to an MT4 bridge to distribute very fast order processing and also a FIX API to integrate into other platforms” she said.

Why a broker needs a prime of prime

“When I think about it, there is a foundation with basic needs, and then extras that motivate brokers to move toward prime of prime agreements. When looking for a partner, brokers want the partner to be reliable and stable, therefore the fundamental matter is to find a company which has a reputable license and a good market reputation.

“Another criteria is to have a partner who is able to fill trades 100% of the time because retail traders will not understand requote or rejection. Fills and execution is vital in the retail market” – Natallia Hunik.

Conditions are not fundamental – performance is more important

Ms. Hunik explained that the expectation but the market is quite different to the reality.

“The expectation is that most brokers look for low commissions and spread. This looks good on paper but there could be slippage, or requotes, and you go to the extent of application, funding an account and find out it is not a good as it first appeared” she explained.

“High Leverage is another thing brokers look for and this is not realistic. If they do offer high leverage, then it is very risky and of course some of the flow is being internalized.”

What is quasi prime of prime?

“A company that calls itself a prime of prime but doesn’t really have all that criteria is not really a prime of prime” said Ms Hunik.

“In the end, issues such as withdrawal difficulties or execution issues that can arise from this can lead to a big withdrawal rate.”

Look for depth of market

“A quasi prime of prime can come along and without depth of market indicator, make the feed as a choice feed on MT4 but you need to look in more detail” explained Ms. Hunik

If the prime of prime is real, there is depth of market because there is always a market depth letter that you can look at and most prime of primes will be able to provide that to you.”

“Top of book is important and down the line it is equally important as if you have a trader that wants to execute $1 million in 1 trade, then some prime of primes are able to customize the price feeds to be able to cover large trades. If you want to do 100 lots in one trade, one order, one fill, there is always ability to customize it.”

Real prime of prime brokers do not offer profit sharing. They also cannot offer high leverage at ratios such as 500:1.

However, real prime of prime brokers do have institutional interfaces to manage omnibus accounts and have multiple methods of connecting to liquidity other than via a liquidity bridge to MT4

Many brokers today are looking to become liquidity providers. Some have partnerships with small local banks that want to deal with brokerages in specific regions but usually when only offering one platform like MT4 they are unable to extend liquidity over other user interface or plug liquidity to their own platform.

There is some flexibility in the market but prime of prime suites which address this issue is important. We have alot of people coming to us wanting to be an LP but need the right tools as they cannot difine mark ups, manage commissions so now the need to address this with Non bank LPs.