How secure is your Tier 1 prime broker? The figures bare all

Banks require high criteria for brokers to obtain and maintain prime brokerage agreements, however how reliable are the banks themselves? PRA new regulation issues data on tech failures by some of the world’s largest Tier 1 FX participants. We analyze why this is important to you

Once upon a time, not very long ago, Tier 1 banks with large market shares in terms of FX dealing at prime brokerage level were often criticized for their execution methodology.

Indeed, this is still very much an important matter, even in today’s vastly more transparent post-financial crisis and post-FX benchmark rigging era in which the transmission of inside data via Bloomberg messenger by unofficial trading groups in various banks in order to gain an unfair advantage is a thing of the past, and the last look privileges of the powers of Canary Wharf widely frowned upon.

These days, however, another perceived shortcoming by major banks has somewhat eclipsed the stain left by the aforementioned practices, that being security issues that have resulted in damage, perpetuated by the retail-facing divisions of the major FX market makers that hold over 49% of the global market share.

The Prudential Regulatory Authority (PRA), which regulates bank conduct is a division of the Bank of England that is largely ignored by participants in the non-bank FX industry, largely because the reporting and overseeing procedure is conducted by the FCA hence all compliance managers and regulatory reporting firms are focused toward the rules laid out by the FCA and not so much on the activities of the PRA.

The PRA, however, is not as impotent as perhaps we are led to believe, and has been conducting further insight into the security of bank systems, and whilst the research and new regulatory scrutiny focuses on banking systems used to support and provide services to retail customers, it could perhaps be a good yardstick in terms of Tier 1 FX dealing, which is a sector largely impenetrable by retail liquidity takers and brokers who are never privy to internal information that is critical to their business.

Today, figures from the PRA noted that NatWest suffered more service and security incidents than any other provider during the last three months of 2018, as customers continued to suffer banking disruption.

Between October and December NatWest reported nine such issues, higher than all of its rivals.

According to the regulator, during the same period Barclays, Cahoot and Santander each suffered seven incidents while Lloyds Bank customers faced disruption on six occasions.

Admittedly, no prime of prime brokerage with a bank relationship would give a cahoot about Cahoot, but Barclays and NatWest Markets are two of the largest FX dealers in the world, and have concentrated continually on centralizing their business away from retail banking and into Tier 1 liquidity provision to OTC FX markets.

Barclays sticks rigidly to its last look procedures via its single-dealer BARX platform, which is instrumental to many FX trades globally.

Two years ago, Barclays’ initiative in this direction expanded further as the bank prepared to close the accounts of 7,000 low-return customers, or move them to another bank in what is being hawked under a politically correct description, that being that it is attempting to reshape its offering to keep pace with tighter capital rules.

More likely, Barclays saw traditional banking as an expensive, resource-hungry exercise and is looking to remove as much of it as possible from the high streets of Britain and Europe, but also under the microscope of banking regulators who know that the company’s legacy systems cannot keep up with modern technology hosted by new non-bank startups.

(As a technologist myself for the last 27 years, most of which involved working on bank systems which were often obsolete before they were implemented due to their enormous size, I’d rather trust Transferwise or Travelex than Barclays with retail tech – Ed).

This is a direction that Barclays has been taking for quite some time. FinanceFeeds was made aware this year by several senior executives of established small to medium enterprises in Britain whose business accounts had been run to perfection, simply finding that Barclays has terminated their accounts.

Barclays is the world’s third largest Tier 1 FX dealer by volume, with 8.11% of the world’s order flow going through its books. Barclays is also one of Europe’s largest retail traditional banking institutions, with a network across the entire continent from its base in London.

NatWest, on the other hand, is part of RBS and has gone all out to attract new FX business from the non-bank brokerage sector.

In summer 2017, FinanceFeeds spoke to NatWest Markets at its head office in London, which showed a very distinct interest in fostering prime of prime relationships with non-bank entities, as long as the relevant (and extensive!) due diligence is completed.

FinanceFeeds followed this up with some London-based prime of prime brokerages, and it appears that most certainly, RBS has the lowest entry barriers and is actually willing to do business as a Tier 1 counterparty. The bank realizes that London’s prime of prime sector is very well organized and is operated by large, well-backed corporations and in some cases hedge funds, and that the rules are followed diligently, hence its willingness to open its doors once again.

In October, NatWest Markets’ parent company, RBS, the world’s seventh largest inetrbank FX dealer by market share, raised the NatWest flag at RBS’ 250 Bishopsgate head office, marking an era of markets-related activity going forward, and today, the bank has taken another step in demonstrating the importance of keeping markets-related business at the very top of its agenda, this time demonstrated by its downsizing of office space.

The bank has today confirmed that its 280 Bishopsgate head office will be sold, and the downsizing of operations that ensues will result in a relocation of staff from 280 Bishopsgate to 250 Bishopsgate, which is home to the firm’s investment banking and electronic trading businesses.

Barclays’ corporate standpoint on the reasons why it uses last look methodology is that being one of the world’s largest interbank FX dealers, it does not generally seek to reject trade requests. However, electronic spot FX market-making is a highly competitive industry and for the reasons set out above it necessarily exposes the liquidity provider to the risk of trading on incorrect pricing.

Barclays maintains that last look functionality is used to protect against these risks and allows liquidity providers to show considerably tighter electronically streamed prices than they otherwise could – something that the bank considers beneficial to every user of electronic FX trading platforms and is very hard line with regard to this.

The bank is aiming to get at least a 10 per cent return on capital from its markets clients and has recently launched a computer system called Flight Deck to help rank customers based on their returns levels and identify those who are currently not making the grade.

With technology at this level, and in house teams with huge R&D capacity, it is a bitter pill to swallow that, in the third quarter of last year, Barclays had recorded the highest number of issues, with 16 incidents between July and September.

As a trading entity, your data security is your intellectual property. How your Tier 1 bank handles it and how secure its systems are is paramount.

The PRA has to be commended for stiffening this regulation and for publishing data that shows how banks fare. Now they need to turn their attention to the trading desk infrastructure for the greater good of the brokerages in our industry that go to such costly ($100 million capital requirement for a prime brokerage agreement!) and such labor intensive measures to provide their customers with quality access to tier 1 markets.

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