The burgeoning demand by retail traders to strike direct relationships with prime of primes that have access to direct bank liquidity is a moot point and has resulted in a tug of war. We dissect the entire situation and speak to the banks and the traders concerned. Feeling the squeeze but tempted? Read on
This week has been a very eventful one in terms of outing what FinanceFeeds has long considered to be the disguised face of institutional non-bank liquidity.
Over a year ago, when it came to light via many dialogues with senior non-bank institutional FX industry executives that AFX Capital was profit sharing instead of placing orders with genuine Tier 1 bank aggregated liquidity agreement, we were bombarded with dissuasive telephone calls from unrelated parties with a vested interest in an attempt to silence the real activities, which have now been fully documented by FinanceFeeds here.
The associated bankruptcy of Gallant Capital Markets, which took the funds of clients of brokers who used the firm for liquidity provision is further testimony to the B-book approach being unfortunately widespread under the guise of promising brokerages access to live markets.
This of course is just one example, and whilst the establishment nestles among the financial giants of the Square Mile, and has done for a substantial period of time – in some cases for decades, however this year, a torrent of newly established prime brokerages and firms offering liquidity has made its way to London.
Hardly surprising, of course, as London is the global centre for Tier 1 bank liquidity provision, as well as for non-bank aggregated liquidity delivered via electronic communication networks such as Thomson Reuters FXall, ICAP’s EBS, or Currenex.
Retail brokerages have never had so much choice with regard to order processing, liquidity management and trade execution methodology.
Nobody wants internalization and revenue share, such is the fear of retribution from the government or clients should an IB lose his client money to an overseas firm – highly frowned upon by the Chinese government, whose social stability policies do not take kindly to firms sending the investments of their clients to unvetted overseas firms that then make off with their capital.
In Asia, things are even more blatant. Liberal use of the words ‘prime brokerage’ or ‘mulitilateral clearing house and exchange’ are rife among some of the domestic firms that have presence across the nation from Shanghai to Shenzhen.
It has been absolutely notable that retail brokerages such as the perhaps unergonomically named G-IMFCH. No, that is not a personal insult, or the sound which accompanying a sneeze, it is an abbreviation of
Global Integrable Multilateral Financial Clearing House. It is questionable as to whether the word Integrable is in the Oxford English Dictionary, however the most important difficulty here is that this is neither a clearing house or a multilateral facility.
In other regions, for example Europe, MiFID categorizes financial markets operators across all of the derivatives sector into three specific sectors – the first being a systematic internalizer (SI), whcih is a counterparty that internalizes (b-books) all trades and is not a trading venue, the second being MTFs and OTFs, which are venues, and the third being a regulated marketplace (RM), which is a trading venue.
The main distinction between RMs and MTFs on the one hand and OTFs on the other is that the execution of orders on an OTF is carried out on a discretionary basis.
The nomenclature of G-IMFCH is at odds with this, yet in China, it is possible to continue with such a name, largely due to language barriers. In Chinese, the firm’s website and its corporate information clearly states that it is an MT4 retail brokerage, and when asked by FinanceFeeds here today in Guangzhou what the firm does, it was explained by staff that the company is an MT4 retail brokerage.
In the West, however, prime of prime brokerage is far more structured and is a well recognized mainstay of the entire business.
The difficulty is that with commercial and professional traders wanting an ever more direct access to bank liquidity, a significant demand for prime of prime relationships with traders rather than brokers has emerged.
Quite what the ultra-conservative FX prime brokerage desks at the Tier 1 banks would make of their counterparty credit agreements being extended past the remit of B2B relationships is interesting to the point that it has been a question that has been met with tumultuous silence every time FinanceFeeds puts it to the suited gentlemen of Canary Wharf.
Indeed, the banal and bogus, as per the example highlighted in China previously here, along with the B-book pretenders with ‘prime’ in their name will take any level of small retail account, because in essence, they are retail brokerages. There is nothing prime about them but that is a different discussion altogether.
Today, FinanceFeeds has become aware of a supply and demand matter that is of great interest, that being the will to expand market share by the handful of genuine prime of prime brokerages that exist in the OTC derivatives sector which is being measured by conservatism.
It is rather like a temptation which is being courted, and in the end sensibility cuts in yet the temptation remains. In essence, we are aware of a sub-category, that being large introducing brokers (IBs), especially in South East Asia – namely Thailand, Malaysia, and Indonesia, who are essentially retail traders (not brokerages with their own regulatory license and trading infrastructure).
These IBs have large client bases and are either managing funds via MAMs or selling expert advisers (EAs or trading robots) to a retail audience and then acting as a referral associate to brokerages.
Such entities are not brokerages, hence the extension of prime of prime services to such entities constitutes a B2C relationship and is outside the remit of the general prime of prime stature as a non-bank distributor of bank liquidity to retail brokerages on a strictly B2B basis, usually integrated via aggregated price feeds and the associated ability to clear with a bank.
One particular IB told FinanceFeeds this morning that “I used to be able to get a direct business relationship with various Australian prime of primes, but now they are telling me to lodge a minimum deposit of $500,000 when it used to be $25,000.
Indeed, banks used to allow prime of primes to operate a counterparty credit agreement with a balance sheet of just $5 million but now it would require $30 to $50 million for a prime of prime relationship, such is the concern over potential default. Thus, the ability to maintain a profitable business with the finite number of retail brokerages which care enough about best execution is a fine line between looking for external financing to lodge as a capital base or going directly to the big direct retail traders.
There is no regulatory stipulation that a prime of prime must not extend credit to a direct market participant, professional or otherwise, but there is a risk management tug of war between the single dealer platform operators at the banks and their own risk management teams, and ultimately within prime of primes, because once a bank decides to remove an agreement, there is very little method of getting it back.
With the banks coming back into the fray, market makers which have likely been very quietly mopping up some of the business that the banks have rejected, are now having to once again demonstrate their competitive edge.
Perhaps going toward the non-bank market makers with such business may be also of interest, in order to keep the banks happy yet satisfy this increasing demand as astute professional traders who are responsible for their client money become increasingly disillusioned with incidents like the aforementioned AFX / Gallant debacle and seek to strike direct relationships with custodians of bank liquidity.
This may be a potential solution but there is also trepidation among the large ECNs.
In August last year, XTX Markets removed its discretionary latency buffers in the last look window when trading with direct counterparties on a disclosed basis, using the terminology “Zero Hold Times” or ZHT in the world of three letter acronyms in which we have so long operated.
XTX Markets, along with Citadel Securities, are two of the most prominently used non-bank institutional liquidity providers and have been building up their base of prime of prime brokerages with whom to use as a distribution channel for their liquidity to retail brokerages which are in turn clients of the prime of prime brokerages, and now operate with the vast majority of companies worldwide.
At a time during which the banks are beginning to realize that the complete curtailment of counterparty credit to FX firms is absolutely counter to their core business activity and is a revenue stream that they cannot afford to ignore, last look has begun to come out of its stalemate situation and is now under the microscope, not only of the regulators, but of a far more aggressive force, that being the litigation suits brought by brokerages.
FinanceFeeds has, during the past few weeks, extensively detailed the litigation instigated by Alpari against several Tier 1 banks
A senior executive within a large American non-bank institutional FX company recently explained his perspective to FinanceFeeds.
“In statistical and absolute dollar PnL terms, 100-300ms last look does very little on benign order flow when makers have good pricing systems and attempt to fill all profitable orders. Most of the venues cap last-look at 100-200ms and require fairly high average fill rates for market-makers. Hotspot publishes their requirements, so they’re worth referencing” he said.
“In other words, in practical terms, last-look doesn’t do much of anything at all when handling retail, small, or GUI order flow. If a new order is randomly submitted against a $20 spread, it’s not very probable that the order goes from being worth $20 for the maker to <$0 w/in 100ms. That’d require a fairly large jump in price for these markets, which is pretty unlikely during any random 100ms window of time” continued the senior executive.
“Put another way, if a maker were to show pricing at, say, a 0.2pip spread (typical), taker orders were randomly in time against that spread, and they maker only filled orders that appeared profitable after 100ms, I’d bet they’d probably fill >98% of orders. The 2% rejected would probably be close to 0 value anyhow, so not a big PnL impact for either maker or taker. I’ve seen first hand examples of essentially this exact scenario” he continued.
This may well be the case for the most part, however Alpari maintains that significant damage was done to its business over a long period of time due to the banks picking and choosing which trades to reject and which to take, when retail firms and prime of primes cannot do that lower down the liquidity chain.
FinanceFeeds spoke to an executive within a large Tier 1 bank last year on this subject, looking at how Tier 1 banks can compete with ECNs and institutional non bank market makers which detail very aggressive client onboarding criteria in order to fill the liquidity void that had been created by banks curtailing their services to prime of primes. The consensus during that conversation was that large market makers may well provide excellent spreads and are a means of avoiding extensive credit checks and submitting large balance sheets in order to gain credit, but stated that in some cases, the fill rate can be as low as 60%, which is far lower than that of a bank, even if last look rejection is being used fervently.