The Relationship Between Brokers And Liquidity Providers

Brokers and liquidity providers are both fighting the same competitive battle, just on different levels.

Brokers and liquidity providers are both fighting the same competitive battle, just on different levels. Liquidity providers work hard to maintain and promote existing relationships with their brokers, but sometimes the broker just wants to know they are being treated properly. I have seen too many cases where a liquidity provider does not have a broker’s best interest in mind. Unfortunately, many new brokers do not have a neutral third party to seek advice.

The latest disturbing case I saw was an LP out of London offering “raw” 0.6 pip spreads on EUR with a commission of $26 per million. I hope the LP behind this quote is reading this, because little did they know initially, but the offer was to one of my clients. That LP never saw or heard from my client again even though they were “friends”. When the LP approached me, the “oops, we gave you the wrong view-only stream” excuse didn’t carry much weight.

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I fully understand that both the broker and LP need to make money, but there is a difference between profit margin and ripping a client’s face off, especially my client. Now that I am done with the above rant, there are three factors that are important when brokers are considering LP’s.

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  1. Spread: Everybody knows what spread is, but most LP’s just talk about their EUR/USD spread. Granted, EUR/USD will make up a good portion of most brokers flow, it is important to evaluate the spread on all currency pairs. LP’s are using EUR/USD as a loss leader or break even pair to get clients in the door.
  2. Execution: Getting a spread of 0.1 or 0.2 on is great, but when the trade is filled, was that really the executed spread? Slippage is a fact of life in the currency markets, but brokers should measure both positive and negative slippage in order to see the real spread they are receiving from the LP.
  3. Service: The level of service LP’s provide varies widely across the globe. Brokers should expect to hear from their LP at least once a week. If any issues occur, brokers should expect immediate response, resolution, and a thorough follow up. The LP space is competitive and not everybody has this service layer nailed down.

Now let’s flip the script and look at things from an LP perspective. The relationship needs to be two-sided and many brokers fail to realize that fact. LP’s need flow in order to make money. There are a few important things brokers need to realize about LP’s.

Important Points To Consider

  1. LP’s are not there to be a glorified B book feed. Brokers that book 100% of their flow might as well find a 3rd party price feed; otherwise the LP relationship will get sour quick. Most brokers understand that brokers will be running some type of book, but there needs to be a balance. I have seen more books of business in this industry than most people, and I have never seen a book that should be 100% internalized.
  2. A true STP LP will have the occasional spread blow out, especially around economic announcements. Spread blowouts are not good for anybody, but banks get a bit defensive and liquidity will dry up at certain times.
  3. A market maker LP may be able to limit spread blowouts, but they will be much more sensitive about the type of flow they receive. Brokers should understand that market maker LP’s are also running a book, just on a larger scale. “Toxic flow” may not be well suited for a market maker LP.

As long as brokers and LP’s are on the same page regarding their business model, then the relationship should be good. It is always a good thing to have an unbiased 3rd party in the conversation if a conflict occurs. Find somebody that thoroughly understands both sides.

Last, but not least – Brokers need to make sure they get a nice steak dinner out of their LP once in a while. I say this half-jokingly, but it is important that a broker and LP get to know each other on a personal level.

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