Interview: FinanceFeeds talks aggregation with Barry Flanigan, Head of Electronic Trading at IS Prime

“Retail brokers generally prefer to adopt a “send and forget” attitude to most of their hedging orders; having direct LP relationships puts the onus on them to carefully manage all flow that they are sending” says IS Prime’s Barry Flanigan

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Within the very upper echelons of London’s FX nerve center, long term tenures at senior executive level are very much the order of the day.

The vast, highly organized and often publicly listed companies that nestle among the world’s financial markets powerhouses represent the pinnacle of today’s non-bank electronic trading world, and comprise the some of the most astute professionals in our business.

Over the course of the last two years, there has been tremendous discourse among industry participants globally with regard to how the order flow of their clients’ trades is being handled by their institutional liquidity provider, and whether genuine aggregated liquidity is being delivered via correct and proper prime brokerage relationships with Tier 1 banks.

Thus, in today’s highly consolidated and rarefied prime of prime sector, how liquidity is managed and how order flow is distributed to and from major market participants is more vital than ever.

Having previously worked in the ISAM group rolling out OTC execution for the hedge fund, Barry Flanigan joined IS Prime at its inception in 2014. He is responsible for running IS Prime’s global trading team, which includes a division that looks after liquidity and the development pipeline for in-house technology. We spoke to Barry about the firm’s product, price delivery to the market and some of the challenges of his role.

Today, FinanceFeeds spoke to Mr Flanigan at the company’s head office in London, to look closely at one of the FX brokerage sector’s most important factors.

What are the key factors to your liquidity management?

Well, the first point is that we focus more on the quality rather than quantity of LPs. Conventional wisdom would suggest that more LPs provide a tighter price.

In the shorter term, this theory does have some merit. However, there is a definite inflection point where incorrect LP additions brings more cost than value, and will often go under the radar with damaging impact.

Accuracy of pricing and quality of execution are two of the implicit costs of adding each additional LP. The more LPs, the greater the probability that there will be an inaccurate or latent quote received, which can be particularly detrimental to any of our clients who are running risk based on aggregated prices.

We have found it is far better to be a more significant client to fewer, quality Liquidity Providers. They tend to stick with you and repay the loyalty – as an example, when core prices go wider, we tend to be the last to be adversely affected, and definitely when market conditions improve we are the quickest to react.

While adding multiple LPs could still improve spreads, this is almost always at the detriment of execution. Issues that can arise, which we are consistently monitoring, include poor fills (partials), delayed execution, high rejection rates or even worse, disappearing prices when you need them most.

Our monitoring and liquidity management is only possible by having the correct technology. With our proprietary software, we have the capability to manage diverse flow styles, route orders, and closely monitor LPs behaviours. The level of granularity to which we do this is one of our largest differentiators, and key to delivering a quality product which withstands the demands of our clients.

How do you define quality?

We look at several factors when assessing our LPs – including but not limited to spread, response time, fill ratios, latency of pricing, market impact and cost of rejections.

Market impact is an important point, assessing how the market moves when we route to one Liquidity Provider vs another. I’ve spoken about this impact before, and feel it still gets wrongly brushed off as a trivial concern. Trading with a counterparty and moving the market away from your order, or your client’s orders – is on average and often more costly than the initial spread.

As for cost on rejections – this is another “hidden” cost that often gets ignored. We receive a large percentage of market orders which are seemingly easy to fill.

The fact though is that LP rejections are passed on to clients in the form of slow execution and slippage. For example, if three LPs reject an order and the market has moved, clients will get both longer execution speeds and larger slippage than if we had filled on the first LP.

What are the issues you find with liquidity management?

True liquidity management requires an intense amount of ongoing analysis, supervision and governance. Spread margins in the industry have squeezed to near zero in majors, therefore LPs are really pricing for volume at low, positive dpm.

The unfortunate result is that an LP can quite quickly get run over in one large move or burst, which if unmanaged can only result in more defensive (read: wider) spreads.

IS Prime has customised liquidity pools, which direct flow specifically to LPs who can manage different types of flow. We do what we can to protect them, which in turn results in spreads being as tight as possible.

It’s about transparency and active management – which gains trust, and is unsurprisingly invaluable to both LPs and clients.

What issues do you see with your clients aggregating your price?

We are aggregating prices from most of the top Euromoney providers and constantly endeavour to keep our flow as ‘clean’ as possible. If clients aggregate our feed with our competitors, the effect is a twice aggregated environment creating a ‘liquidity mirage’.

The perceived upsides for clients are that you have more depth and better spreads, but this is actually a misleading quote book.

Executing across multiple venues using the same LP contributors will result in double hits on the same market makers – who are forced to widen pricing or increase rejection rates for both brokers, regardless of the efforts taken on our side to prevent this.

This, coupled with the operational issues of aggregation – ie: enabling non-netting of positions across multiple brokers, causes cash management issues and is obviously technology intensive and overcomplicated – is just a few reasons why we strongly advise any clients not to aggregate.

So surely your clients would do better to have their own direct relationships with these banks?

This is absolutely not the case in most instances, for a number of reasons. In order to get competitive quotes from a direct relationship with a tier 1 LP, you need to be hedging a significant amount of volume, and you need to be sufficiently sophisticated to know what flow to send to which LPs.

Retail brokers generally prefer to adopt a “send and forget” attitude to most of their hedging orders; having direct LP relationships puts the onus on them to carefully manage all flow that they are sending.

A good Prime of Prime will be able to do this on a client’s behalf, and maintain better pricing and trading conditions on the client’s behalf than a client would be able to achieve themselves.

It takes a full suite of sophisticated technology and a team to do this correctly. Handling the routing of thousands of retail trades per second and monitoring LPs spreads and stats (as mentioned above) is a huge task, not to mention looking after all those LP relationships individually on a daily basis.

Also, without the benefit of netting flow from different client profiles, you’d be concentrating the risk of spreads going out to direct single end-points if it’s not managed correctly.

We pride ourselves on our position as a market leader, acting as a sole LP to many of the largest retail brokers in the market, but we are only able to do this due to our specialised expertise coupled with the proprietary systems monitoring these at an institutional level.

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