In these times of no credit, the major venues and non-bank LPs are becoming the liquidity innovators

It is nigh on impossible to obtain credit these days.

OTC derivatives providers are locked in a constant battle with the Tier 1 banks which have thus far been the critical component with regard to providing the top level liquidity to aggregators and prime brokerages in order for the retail OTC derivatives industry to emulate the market infrastructure and topography of the institutional world.

These days, however, obtaining relationships with Tier 1 banks, and perhaps even more difficult, maintaining them, has become a source of the arrested development of the free flow of capital from banks to trading platforms and vice versa.

Citigroup, the largest interbank FX dealer in the world with over 16% of global FX order flow being processed via its Canary Wharf headquarters, recently stated that the OTC derivatives business has a potential default rate of 56% when extending credit, thus it, along with all of the other Tier 1 banks have restricted the outflow and inflow of derivatives order flow, and with no higher level than the Tier 1 banks, the question remains – where to go to operate a trading business and provide best execution?

Of course, running a b-book, and then obtaining a live price feed from a Tier 1 provider or prime brokerage is one method, therefore internalizing trades at broker level, but following the live price feed of the aggregated liquidity provider, however for those brokerages wishing to continue to be able to send orders up to the liquidity provider and the bank, greater relationships are now required, and innovation in terms of execution facilities at the venues rather than the banks.

London is not only booming as a financial center and continues to lead the way for all things institutional and interbank, but despite the very risk averse nature of the City’s (for that read the world’s!) Tier 1 bank liquidity providers, London is also becoming an epicenter for new Prime of Prime innovation.

For the last few years, many retail FX brokerages have remained unconcerned with the complexities of the technological and business relationships that are instrumental to the delivery of high quality market liquidity at all times, largely because until recently, the top end of the chain, the banks, had extended credit to prime of prime brokerages without ado.

Effectively the banks either will no longer extend credit, or they will request much bigger balance sheets. $250,000 would easily have got a Prime 5 years ago, whereas we are now talking about minimum amounts in the region of $15 million, and in some cases between $25 million and $100 million with some of the large Primes.

For this reason, 2016 has become a year in which prime of prime services and the connectivity providers that facilitate their link to the live market and to retail brokerages have had to innovate substantially in order to provide better prime of prime relationships and access to best execution for the brokers that use the services.

The brokerages and integration firms have become very involved in creating their own structure around fostering greater prime brokerage relationships this year, with some new and very interesting prime brokerage services from ADS Securities, CMC Markets and AFX Capital, some of London’s very highly capitalized brokerages which have headed down the institutional route.

Perhaps rather unusually, Euronext has been the latest contingent to join the fray, it being an electronic executing venue which processes derivatives order flow as well as stock, however the most unusual aspect of this is that Euronext is based in Amsterdam, not London, yet it is angling its service toward London’s institutional sector.

Having spoken at length to a number of senior executives in the institutional sector, FinanceFeeds has deduced that the key to greater liquidity access in today’s credit crunch-hampered money market is greater prime of prime relationships and the development of ecosystems which reduce the cost per million and create access to wider pools of liquidity at non-bank level.

Euronext is conducting this by introducing a new service this year which will create more opportunities for market participants to execute large-in-scale orders on its own regulated market.

The ideology behind this new ‘liquidity discovery’ solution is that it aims to enable a major new source of hidden liquidity by leveraging Euronext’s Central Order Book, and will be available from approximately mid-September this year, pending regulatory approval.

Euronext plans to establish this method of liquidity provision by tapping into a large European hidden liquidity pool, and via improved use of what is termed as ‘iceberg orders’, those being large single orders that have been divided into smaller lots, usually through the use of an automated program, for the purpose of hiding the actual order quantity.

Euronext intends to improve the use of iceberg orders in its quest for greater hidden liquidity provision by enabling participants to randomize the disclosed quantity of the iceberg orer to further improve prevention of the detection of such iceberg orders.

Once this has been done, undisclosed portions of iceberg orders will be permitted to execute against each other at any price, including midpoint.

In addition, Euronext intends to introduce a new hidden order type without displaying price or volume in which orders may be executed against each other at any price, including midpoint.

At institutional level, brokerages with institutional divisions (retail brokers that also provide liquidity to other retail brokerages via specialist prime brokerage divisions) as well as prime of primes such as Saxo Bank which executes its orders via a series of aggregated bank and non-bank liquidity providers and electronic communication networks, will be able to add this to their feed.

We may well be entering an era in which the heyday of the non-bank liquidity providers is upon us, as a result of circumstance, however innovations such as this are likely to be instrumental to the preservation of top quality order flow processing and ultimately the ability for all firms to maintain best execution in these times of bank apathy.