Consolidation in the forex prime brokerage (FX PB) sector is becoming increasingly apparent, especially to hedge funds. A new report by Acuiti, commissioned by Standard Chartered, underscores the growing concerns among fund managers about the adverse changes occurring in the sector. The study, based on interviews with 57 hedge fund operations executives, shows that nearly 40% have reduced their FX PB partnerships in the past three years, often because providers are exiting the market.

Declining Number of FX Prime Brokerage Relationships

The report revealed that hedge funds are increasingly worried about the thinning landscape of FX PB providers. The most common reason for reducing these relationships was an internal consolidation decision. However, one-third of the firms that reduced their FX PB providers did so because their existing broker withdrew from the market, while 24% were forcibly offboarded.

Firms that were either offboarded or whose provider left the market reported multiple challenges. These included reduced access to liquidity, the costs associated with onboarding a new broker, and heightened operational and settlement risks. Notably, more than a third of these firms lacked a contingency plan, further intensifying their concerns.

“Hedge funds are highly reliant on their FX PB providers and it is no surprise that levels of concern are high across the market,” Ross Lancaster, the Head of Research at Acuiti, commented.

Also, the industry's risk profile has undergone scrutiny following several high-profile losses, including the Archegos Capital Management collapse. These incidents have led to increased minimum monthly commissions and the offboarding of smaller firms that offer lower transaction volumes, creating a two-tier market.

“There is an opportunity for expansion among the sell-side to meet the demand from hedge funds both to access unique trading opportunities in emerging and frontier markets but also to reduce operational risk associated with the dependence on specific providers,” Lancaster added.

Satisfaction Levels Vary by Firm Size

In addition, the study found that smaller hedge funds, particularly those with Assets Under Management (AUM) of less than $1 billion, risk facing limited provider options.

Hedge funds' contentment with the number of available FX PB providers differed substantially based on the size of their AUM. Around 43% of firms with an AUM of less than $1 billion expressed dissatisfaction, compared to only 12% and 8% among firms with an AUM of over $5 billion. Consequently, smaller hedge funds are increasingly dissatisfied with their limited options.

In 2023, there has indeed been little talk about new FX PBs entering the market. Instead, the focus has been on existing firms being acquired. For example, in September, Marex announced the acquisition of Cowen's prime brokerage business. However, the cryptocurrency market offers an opportunity for industry growth, where investors are continually seeking greater trust.

Impact and Future Outlook

Over half of the surveyed firms were quite concerned about the possibility of their FX PB providers exiting the market, while 16% were very concerned. Andy Ross, the Global Head of Prime & Financing at Standard Chartered, noted that hedge funds are facing increasing challenges in finding a reliable FX PB provider, particularly as they seek to expand their currency trading strategies.

Therefore, as the market continues to evolve, hedge funds must be increasingly strategic in choosing their FX PB providers, especially in a consolidating market that poses both operational and liquidity risks.

“At the same time, with ongoing growth in the global market place, hedge funds from across the world are looking for a partner that can provide access to a broad spectrum of currencies to optimise their trading strategies,” Ross concluded.

This research report draws upon a survey involving 57 hedge funds, with participants hailing from various regions, including North America (19%), the European Union (24%), the UK (29%), Asia (22%), and other parts of the world (6%). The AUM for these funds ranged from $0-100 million (11%), $101-500 million (16%), $501 million-1 billion (14%), $1-5 billion (23%), to over $5 billion (37%).