Why is Everyone Looking for FX Prime-of-Prime?

This article was written by David Vanstone, Director of Institutional Sales at Invast Financial Services. Invast provides a comprehensive choice of platforms and connectivity options, including direct API solutions, Invast IRESSTrader, Invast MT4, Invast ST24, and Flextrade MAXXTrader.

Tightening Credit Allocations

Credit has always been the lifeblood of Foreign Exchange (FX), given the bilateral nature of the market. The Global Financial Crisis (GFC) in 2008 and the resulting changes in global regulations has had, and will continue to have, a seismic impact on how FX Prime Brokers (FX PBs) allocate credit.

In the aftermath of the GFC, FX PBs acted quickly to reduce their counterparty exposure to the more risky, less capitalised clients. More recently the Basel III capital reforms that started in 2010 require banks to be better capitalised through increasing Tier 1 capital, whilst simultaneously reducing leverage. These reforms have significantly changed the pricing models of FX PBs and the attractiveness of certain client segments to them.

The pace at which FX PBs have pulled back from smaller clients, including retail brokers and small/medium-sized hedge funds, has accelerated dramatically in 2015. This has been the result of significant FX market events, such as the Swiss National Bank abandonment of the cap on the franc’s value against the euro in January 2015. This event and the heightened regulatory scrutiny on FX after the numerous, highly-publicised bank FX scandals, appears to have further incentivised FX PBs to tighten up FX credit allocations for certain counterparties.

Accelerated Expansion of FX Prime of Prime (PoP)

The tightening of credit allocations and margin requirements by FX PBs has enabled the accelerated expansion of PoP and specifically those firms with strong balance sheets, advanced technological expertise and a long corporate heritage in FX.

Clients now serviced by PoPs are benefiting from greater leverage than they were previously being offered from Tier 1 FX PBs. They often face more flexible commercial arrangements at a PoP broker and they are being offered bespoke technological solutions through which they can access a single pool of aggregated Liquidity Liquidity The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent Read this Term via a range of different channels and structures. FX PBs have admitted that there is considerable room for PoPs in this segment, as clients need to be serviced by institutions best equipped to handle their needs. At our company, over the past 18 months, we have had many PBs coming to us with clients they are looking to offboard, grateful that they have a destination to place their clients where they know they will receive top-tier trading conditions and service. Some of these clients have been long-term relationships for the PBs, so it is quite an honour to be chosen to take on the referral.

The attractiveness of the rapidly expanding PoP market has led to many new entrants, of various calibres, from around the world. Which begs the question; who is best positioned to succeed in the PoP space?

Who is best positioned to succeed in the PoP space?

It has become evident that in order to be a long term success in the PoP space, firms will need to be highly capitalised with strong balance sheets. This, along with having strong relationships with multiple Tier 1 FX PBs and Liquidity Providers Liquidity Providers A liquidity provider (LP) constitutes an individual and/or an institution that functions as a market maker in a given asset class. Broadly speaking, liquidity providers will act as both the buyer and seller of a particular asset, thus making a market. In the equities space, many stock exchanges rely on liquidity providers who make the commitment to provide liquidity in a given equity. These liquidity providers commit to providing liquidity in the hopes that they will be able to make a profit on A liquidity provider (LP) constitutes an individual and/or an institution that functions as a market maker in a given asset class. Broadly speaking, liquidity providers will act as both the buyer and seller of a particular asset, thus making a market. In the equities space, many stock exchanges rely on liquidity providers who make the commitment to provide liquidity in a given equity. These liquidity providers commit to providing liquidity in the hopes that they will be able to make a profit on Read this Term will help ensure favourable and stable commercial conditions (fees, spreads, leverage and NOP) for the PoP client. The importance of having access to a strong and stable PoP broker will increase as the impact of the implementation of Basel III continues and more and more PBs leave the space.

PoPs residing in reputable jurisdictions appear to be at an advantage as clients are increasingly conscious that their PoP partner is governed by a strong regulator and has robust protection for client money. Similarly, sophisticated clients are increasingly looking for PoPs who align themselves with their needs by acting purely as an agent through which they access both bank and non-bank liquidity.

Finally, a PoP needs to have a strong commitment to the PoP space, have exceptional technological capabilities, along with a dynamic corporate culture in order to adapt to the changing demands of clients and the evolving FX market.