Understanding Sub Prime of Prime

In the last few months, as the world has started opening up again, my team and I have attended a number of expos across Europe and the Middle East.

It has been great to get out and meet clients and to see what the technology providers and peers in the space have been working on over the course of the pandemic.

One of the most noticeable (and potentially alarming) trends has been the massive expansion of the number of businesses labelling themselves as “Prime.”

My theory is that the enormous revenue boost from the pandemic led to many brokers spending this dividend on excessively generous IB rebates, and that this has come to haunt them now that the market volatility has reverted to normality.

This in turn has led to mounting pressure on brokers to drive growth.

Many retail brokers seem to have decided that a potential growth path was to create a sub-brand of their existing offering, and now market themselves as a “true institutional Liquidity provider” giving “direct access to Tier 1 LPs,” or something to that effect.

Jonathan brewer — Jonathan Brewer, Commercial Director, ISAM Capital Markets and Managing Partner, IS Prime

I do understand why this is – pitching your business as an institutional liquidity provider is a sensible step and a sensible evolution of any business. It has the dual benefit of accessing another segment of the market, alongside impressing retail clients as they believe they are trading with a “true institutional LP.”

The reality, however, is that in order to provide a proper value add solution, you have to do more than simply add the word “Prime” onto the end of your company name.

The FX liquidity space has always been very fragmented, and it is hard for clients to really understand the difference between a company that is offering a real service, as opposed to another company that is providing a similar looking offering but in fact are simply re-selling a third party solution and adding an additional layer of cost.

When a retail broker accesses liquidity, the service that they are paying for is risk transfer (paid by crossing the spread) and clearing, which is usually paid for in commissions.

Typically, the former is paid to a liquidity provider and the latter to a Prime Broker or Prime of Prime.

The key point here is that the further away you go from a counterparty with a true prime brokerage relationship, the more mouths have to be fed and the higher the cost.

This can be explicit, in terms of commissions, or implicit in worse spreads and swaps. There are also potential concerns on how those businesses are monetising your flow through B-booking it and hoping for the best.

An average “Prime of Prime” packages both liquidity and clearing together, but an excellent Prime of Prime – one that adds true value - extracts revenue from both spreads and commissions, thereby cross subsidising both revenue streams and sharing the benefits back to the client. This can come in the form of better commercial terms, or even an explicit share of revenues.

An excellent Prime of Prime therefore should be able to offer a client better transaction costs than those that they would access themselves if they were to operate with a tier 1 PB and pay spreads to Liquidity Providers .

A “Prime of Prime of Prime” or “sub prime” provider more often than not solely represents an additional mouth to feed, an additional technology step in the chain (i.e. an additional potential point of failure) and an additional credit risk.

Now that we’ve addressed what “isn’t” a Prime of Prime, I thought it would be a good time to look at what is and to revisit our insight into “Evaluating a PoP liquidity provider.”

As a broker, the liquidity you deliver to your clients is of paramount importance. In this guide, we equip you with a set of questions that will help you evaluate a ‘Prime of Prime’ liquidity provider in order to better differentiate a best-of-breed offering and ensure the services you offer are most appropriate both for your own firm and for your clients.

This article was written by Jonathan Brewer, Commercial Director, ISAM Capital Markets and Managing Partner, IS Prime.