Prime of prime relationships and the future – Enterprise quality connectivity at just $1 per million is here! FinanceFeeds investigation

“You can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future.” – Steve Jobs. The dots in this particular instance are represented by all of the components of the electronic trading infrastructure that makes up today’s multi-faceted environment […]

Prime of prime relationships and the future

“You can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future.” – Steve Jobs.

The dots in this particular instance are represented by all of the components of the electronic trading infrastructure that makes up today’s multi-faceted environment from which retail traders can now experience similar levels of sophistication to that of the proprietary trading desks of New York and Chicago.

Instrumental to bringing real time pricing and best execution via Tier 1 liquidity to the trading platforms used by retail traders are the array of integration companies that have developed ancillary software and risk management systems that have adapted the MetaTrader 4 platform to operate on a ‘direct market access’ basis.

Originally, when the MetaTrader 4 became available, it was designed to be used as part of a closed system. Brokers of the time often used an all-in-one solution from MetaQuotes which included a dealing desk via which retail brokerages executed trades in house, thus giving rise to the profit and loss remuneration model whereby many retail brokerages at the end of the last decade capitalized their businesses on the losses of traders.

The maturity of the liquidity bridge – to the benefit of Prime of Prime relationships

The invention of the liquidity bridge was the first step toward bringing real market pricing and best execution to within the realms of the retail trader, a marriage between Tier 1 aggregated liquidity (generally aggregated and provided by technology firms other than the companies developing MT4 Bridges) and the hedging functionality and compatibility with Expert Advisers that had created the backdrop for the popularity of MetaTrader 4.

Nowadays, this model is very well established. However there are industry opinions which emanate from the very same innovators and technological leaders who developed the liquidity bridge in the first place which demonstrate that a new evolution is on its way.

A dynamic which is as concerning as it is important has developed this year, that being the difficulty for FX brokerages to gain access to the credit relationships needed to access Tier 1 liquidity as interbank dealers. Many of the firms which previously serviced this demand made substantial losses during 2015, and are taking a very close look at counterparty credit risk moving forward.

Andrew Ralich, CEO, oneZero

This has a very significant effect on the means by which less well capitalized prime brokerages can obtain credit from banks and subsequently means that retail brokerages are left with very few options in terms of relationships with prime brokerages or prime of prime services. Whereas prior to 2015-2016, credit was readily available for all levels of firms participating in the Retail FX vertical, today credit is much harder to come by, and it comes at a significantly higher cost.

Quite clearly, the lack of cost-effective credit options for the retail sector to emulate the professional and commercial model seen at the interbank / traditional FX clearing level has driven the cause for a solution that satisfies the demand for credit availability, lowers costs to enter the market, and disrupts the previously held assumptions about the relationships between liquidity, credit, and broker.

Imagine a world where brokers who were previously restricted by the technology available to their place in the value chain were now able to offer credit and liquidity in a similar fashion to traditional prime brokerages.

There have been incidents recently, particularly as a result of the Swiss National Bank’s removal of the 1.20 peg on the EURCHF pair in January 2015, which caused the insolvency of some prime brokerages, notably Boston Prime, soaked up client funds like a dry sponge in an oasis, and left brokerages unable to pay client withdrawals, with very little recourse except for waiting for the insolvency practitioner to set a cents-per-dollar settlement amount.

Yet still this model reigns supreme, and the demand for credit is stronger than ever.

There are very few retail OTC prime brokerage firms that are absolutely not exposed to any risk if every trade is sent directly to market. Even the major banks which handle the vast majority of interbank FX order flow have now moved away from this model altogether – for example, Citigroup, the world’s largest interbank FX dealer, exited the retail sector altogether by offloading CitiFX Pro, its retail prime brokerage division, just 3 months after the SNB event.

That particular event has resulted in a number of changes to the OTC FX industry, however most of them have been cautionary. It would take a very innovative disruptor of technology to bring something revolutionary into the sector in order to address this and still progress in an onward direction.

Today, FinanceFeeds spoke to Andrew Ralich, CEO and Founder of oneZero. Mr. Ralich is a very widely recognized industry figure and a regular speaker at large FX industry conventions with regard to connectivity and how liquidity relationships should evolve via technological advancement.

Mr. Ralich explained, “oneZero developed a reputation for reliable, enterprise quality technology in the development of our MT4 Bridge product back in 2009. Today, we are addressing a much more pressing concern within the industry: the diminishing credit and liquidity options available for brokers looking to STP their trade flow.”

“In January of this year, we delivered our Margin Hub solution to the industry. This allowed brokers utilizing oneZero’s connectivity for Retail Platforms to offer API based liquidity to other brokers, with all the tools needed to manage pre-trade risk and post-trade reporting.” said Mr. Ralich.

As far as functionality is concerned, the oneZero Margin Hub solution now combines three components in order to provide services as a retail-facing and B2B clearing counterparty in the OTC FX industry, and is able to provide such connectivity to retail platforms such as MetaTrader 4 and cTrader. Previously, connectivity solutions available to FX brokers generally provided only one of these options, and the combination of both an institutional platform and enterprise quality Bridging solution have become cost-prohibitive in today’s credit market.

Want to execute at $1 per million? Here’s how!

“The uptake of our Margin Hub solution has been a very exciting aspect of Q1 2016 here at oneZero. We’ve onboarded nearly a dozen firms to our ecosystem who can now provide liquidity to other brokers. We find that, when two oneZero brokers connect together there are significant synergistic benefits to both oneZero and our clients.

We want to pass this savings down to the broker, and are now launching a campaign where oneZero clients who Bridge to oneZero Margin Hub users will be able to reduce their technology fees to $1 per million. We feel this is an unprecedented and disruptive move in terms of the traditional pricing structure for enterprise Bridging solutions. A list of our ecosystem partners can be found on our website.” – Andrew Ralich, CEO, oneZero

Providers in the FX clearing vertical have seen similar “ecosystem” style pricing models in the past, but never before have brokers been able to extend such an ecosystem from an aggregated, Tier 1 margin-capable solution all the way down to MT4 bridging.

Though this trend is new to FX, it has proven precedence in other financial markets

Since the adoption of third party technology which has adapted the MetaTrader 4 platform to connect to aggregated liquidity feeds, many brokers now seek to onboard sophisticated retail traders with direct market access and very fast execution, however it is still a yardstick short of the institutional model used in both Wall Street (New York) and State Street (Chicago).

Yes, exchange listed derivatives are expensive to clear, because the market maker has to become a clearing member, which usually has two costs – membership fees which are upwards of $500,000 per year, and clearing costs which are several hundred thousands of dollars per month depending on volume.

At the FinTech Exchange 2016 event in Chicago last month, FinanceFeeds deduced that many exchange technology providers and listed derivatives platform companies are innovating their services in order to appeal more toward retail traders.

Whilst this is an excellent direction for North America’s giants, the general investing profile of retail traders who execute futures contracts via exchanges is such that far higher deposits and margins exist, therefore rendering such systems the preserve of the professional trader or longstanding investor with a larger portfolio than an average retail OTC FX trader outside of North America.

By reducing the cost per million down to $1, oneZero approaches a subject that has been a moot point for some years – indeed ever since the introduction of direct market access liquidity – that being the cost of execution, capitalization of platforms, remuneration of introducing brokers, and volume-based prime brokerage costs when spreads are at an all-time low.

The introduction of oneZero’s margin hub for business-to-business relationships has provided the basis for prime of prime solutions providers to really extend their services at a time at which the entire business is looking at costs.

On June 30, 2014, Citigroup, the world’s number one FX dealer by market share, handling 16.11% of the global interbank order flow in 2015, published a corporate document on advanced approaches and disclosures for the Basel III regulatory framework for banks which separated OTC derivatives business in terms of probability of default (PD) compared to many other aspects of business.

When taking a look at the risk weight which was determined by that report, despite the much lower capital provided, the probability of default is substantially higher as per this table:


Source: Citigroup

Just two months later, the low volatility of the markets was emphasized by FXCM CEO Drew Niv in the second quarter earnings call of 2014, further illustrating the safe situation that the markets had been in for a sustained period of time “The challenging market conditions continued in Q2. Currency volatility which has been declining steadily since June 2013 continued to drop throughout the second quarter hitting record lows near to end of June and continuing to drop in the month of July” said Mr. Niv at the time.

As the call continued, Mr. Niv stated “The volatility dropped to levels lower than any in the 21 years since the currency volatility index has been calculated. Last quarter, I said that the first three months of this year were the worst trading conditions I had seen in the 15 plus years I have been in this business, and I need to revise that statement that Q2 was much worse.”

The ‘ecosystem model’ is the future – Here is how it works

Mr. Ralich then explained how the ecosystem model works.

“The ecosystem model should be a methodology by which the industry can create a new reference point” he said.

“PrimeXM went down this route quite successfully, and Integral Development Corporation made some attempt, however the solution offered by Integral lacks solid connectivity to retail brokers” explained Mr. Ralich.

“From a specification perspective this ecosystem model is a big development for the future. Retail firms get a discount, and technology providers need solid connectivity. By operating in this manner, integration companies can provide a prime brokerage solution and retail solution within the same technology ecosystem.” – Andrew Ralich, CEO, oneZero.

The development toward a model which emulates that of the institutional world and provides a hub in which prime brokerages can create more substantial relationships between themselves and retail FX brokerages is most certainly an answer to a long-standing issue.

Whilst many place an emphasis on the Swiss National Bank’s removal of the 1.20 peg on the EURCHF pair in January 2015, the considerations and challenges to the original model date back quite some time.

In 2012, professional services company Ernst & Young produced a report on elusive revenues which concentrated on the pressure on fees and the multi-prime trend in the prime brokerage industry and how it was slowing the industry’s full recovery from the depths of the recession, spurred by the 2008 and 2009 financial crisis which affected many of London’s major banks, which are among the world’s largest interbank FX dealers by market share.

Global prime brokerage revenues in 2012 were estimated at $12 billion, down from $15 billion in 2008, a figure which signaled the beginning of a prolonged dip.

Ernst & Young deduced that there were more active firms gathering market share post-financial crisis and that revenues at individual firms may have decreased more than the aggregate figure suggests.

At that time, prime brokers had been the beneficiaries as hedge funds diversified away from the giants, and international firms such as Deutsche Bank and Credit Suisse – both companies which now have massive difficulties in terms of vast losses on their balance sheets – had made large inroads in the Americas.

Four years ago, liquidity management was an area that Ernst & Young considered could benefit from better data management processes and technology.

The biggest prime brokers at the time were at the time still part of larger banks and financial services firms, of course, meaning they can obtain capital inexpensively and achieve the ability to withstand large cash fluctuations.

Still, 71% of the prime brokers surveyed by Ernst & Young at the time during which prime brokerage productivity began to tail off did not have a method for notifying their treasury group of large cash inflows and outflows.

The 29% that did have a notification method used email and phone calls to inform treasury. However, the prime brokers at the time speak with their clients about the best times for cash deposits and how funds expect the prime broker to help to manage their liquidity needs.

This is now a matter that has been addressed within the ecosystem model.

As a side note, back in 2012, it was also the case that all brokers admitted to Ernst & Young that they would not refuse a cash deposit.

Caution, in that case, was on the cards as long as four years ago, the Swiss National Bank’s actions on Black Thursday having been a further catalyst,

With relationships hard to develop and credit risk high on the agenda, a hub from within which prime of prime providers and brokerages alike can connect on both sides has to be a very welcome addition to the landscape indeed.

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