The foreign exchange prime brokerage (FXPB) sector has become a topsy-turvy area of the overall FX industry during 2014. Earlier in the year, Rabobank closed its FXPB unit following a period of absorbing credit related losses from one of its clients as well as seeing its department head leave. This was followed by the exit of the Head of FXPB at SEB Bank, Noel Singh, leaving his position, along with the bank putting a freeze on onboarding new customers. In addition, after becoming one of the drivers of lower fees in the industry in the beginning of the decade, as of last year, Morgan Stanley is believed to have dramatically reduced its FXPB footprint.
Adding to these events, Forex Magnates has learned that Global Head of FXPB at Bank of America Merrill Lynch (BAML), Peter Klein, has left his position at the bank, a role he had held for nearly three years. The exit occurs as the FXPB unit has also been attributed to have been dropping customers as it reduces its credit exposure, specifically to clients allegedly involved with high-frequency trading. Upon reaching out to the bank, the firm provided no comment to Forex Magnates on Klein’s exit or to his successor.
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During 2013, often mentioned was the FX industry’s vulnerability to systematic risk as margin compression on market-making had reduced the amount of primary bank dealers to only a handful of major participants. However, the opposite has actually occurred over the past twelve month, with most top five primary dealers reducing their market share slightly as they have become more discretionary and have reduced liquidity distributed to less profitable customers and venues. In addition, with reductions in the barrier of entry due to decreasing costs of eFX technology, non-bank market makers and Tier 2 regional banks have successfully been able to become liquidity providers and grab market share.
Replacing liquidity concerns and becoming a major issue in the institutional space recently has been a contraction of available credit. The lifeblood of activity in the FX market, firms rely on their FXPB relationship to provide them with credit lines to trade across multiple ECN venues as well as directly with primary banks. However, due to what is being viewed as gaps in technology, prime brokers are finding it more difficult to accurately monitor customer positions usage across multiple lines of credit. Specifically during active periods in the market, often related to the dissemination of economic news and volatility spikes, some FXPBs have reported slight latency in receiving trade reports, which are used to compute total client exposure. As a result, FXPB customers with a ‘rogue’ algo may be able to surpass their overall margin limits in enough time to cause significant losses before becoming detected. In such a scenario, the prime broker would be on the hook for losses greater than the value of their client’s collateral.
Due to the credit risk, multiple sources have reported to Forex Magnates that onboarding of accounts at FXPBs has lengthened from a two to three month affair, to typically in the six month range. While the onboarding delays can disrupt the launch of new trading activity, more problematic are the out of the blue closures of accounts when customers are given 30 days notice in order to find a new FXPB. In lieu of the onboarding problems, sources have stated to Forex Magnates that some so called ‘Prime of Primes’ that have relationships with a major prime broker and extend their credit lines to their customers, have seen demand for their offerings. (More on the Gap in the Market)