The ever-evolving world of foreign exchange prime brokerage, a premier service for premier clients, is in the fast-track queue for change. The once thriving sector has seen an overhaul of operations as the risk vs reward element of the offering comes under fire from management.

The PB space has taken a back seat over the past 18 months with banks either consolidating or completely withdrawing from the space. The events of the 15th of January added salt to the wounds of users as banks up-the-tempo making the VIP club, even more difficult to enter.

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Banks responded to the Swiss franc crisis quickly, with several PB clients receiving notices of changes to their accounts with some benefiting from simple changes in leverage, and others facing the brunt with termination notices.

“The events in January caused this evolution to be greatly accelerated as the traditional prime brokers reassess the risks involved, how they can control those risks and how they should price credit market access,” says Peter Plester, Head of FX Prime Brokerage at Saxo Bank. The FXPB market has been evolving for the past few years, with some large banks either scaling back their prime offerings or simply pulling out altogether.

2008 Genesis

The troubles of the 2008 downfall with Lehman Brothers and AIG sent a strong message to users and hedge funds, banks and retail aggregators establishing multiple relationships with prime providers, however the trend has been declining since peaking in 2010, with the average number of total prime broker relationships dropping from 4.8 to 2.7 providers over the last four years, according to research by TABB Group.

Tom Higgins, CEO of Gold-i, a technology provider to derivatives firms added: “We have been told that some brokers are finding it harder to get a PB relationship and if they can, it is more restrictive, with lower leverage offered.”

Among the numerous services prime brokers offer, one is leverage, during the midst of the crisis it was evident that clients who were over-leveraged were directly affected and a domino-style would affect each provider back to the bank.

Banks that continue to offer the service have done so with a pinch of salt, users seeing radical changes with increases in capital requirements and transaction fees, on the other hand, reductions in the amount of leverage offered.

Capitalisation Is King

The prime brokerage business comes at a price. Banks use their balance sheet to hand out credit, coupled with some complex approaches such as four-way give-ups, reinforcing the notion that PB desks are prone to trading volumes. The impacts of low volatility affected a number of providers who simply weren’t making enough money, with the slowdown in activity.

Furthermore, although costs are being reduced with advancements in technology and systems such as Traiana’s Harmony platform, the sustainability of running a profitable PB desk has its concerns.

For firms that can afford the new increased collateral levels opportunities avail them, the thriving Prime of Prime sector, a second-tier offering that allows banks or brokers to redistribute their credit relationships with their prime broker to users who are unable to meet the hefty criteria set by the banks.

The rise of costs may also affect the level and scope of services offered. “High margin rates and larger fees are here to stay for the foreseeable future,” says Wayne Roworth, Co-Head of e-FX at Sucden Financial. “This variation means that clients will expect more from their PB – better service and greater access to multi-asset clearing.”

In the aftermath of the CHF debacle, capital requirements have risen five-fold with tier-1 providers requesting as much a $50 million on the balance sheet. The days of cut-price PB offerings are over with tier-2 providers raising their threshold to at least seven figures.

Where to Now?

Mini prime providers have seen an uptake in enquiries and clients diverting their business to the emerging providers. With some firms offering replicas of a bank’s service, in addition, the emergence of non-bank liquidity providers feeding into PoP price aggregators has assisted the PoPs to capture the baffling accounts.

“Saxo Bank has seen a large number of new clients looking to on-board. Although our fees and collateral requirements have been broadly unchanged, the leverage we offer has been reduced somewhat in line with the rest of the market, taking into account the recent rise in volatility,” adds Mr. Plester.

The market is experiencing a change which could alter the entire outlook for an FX broker. If banks continue to raise the bar, users could be immune to the STP model and alternative options such as hedging on exchange could take precedence.