TOP OF THE POPS.
Best Execution asks FxPro CEO, Charalambos Psimolophitis, about the emergence and evolution of prime-of-prime brokers in FX.
The financial crisis and ensuing regulation has resulted in a dramatic tightening of credit conditions and an end to the generous credit lines and limits that allowed FX market participants, banks and their clients alike, to trade freely with each other. How are prime of prime brokers filling the gap?
As is often the case after a financial crisis, regulatory oversight tightens, risk-aversion sets in, and the big players are more reluctant to enter into new credit relationships. 2008 was no different. But even when the credit lines were disappearing, the need for liquidity in FX continued to grow. In the retail space many new traders came to the market precisely at this time, perhaps seeking new ways to take the reins of their finances. These growing needs, both in the retail and institutional space, led to many smaller primes and prime-of-primes entering the market.
How do they differ from the traditional prime brokerage counterparts?
Prime-of-primes are smaller and offer access to their existing credit relationships. This makes them ideal for businesses that are not able to generate the volumes required by the big banks. This drop-off in available liquidity for smaller firms has led to the boom in prime-of-primes that we’re seeing today. But aside from liquidity, prime-ofprimes are more agile, and are able to offer an increasingly tailored service, having gained a great deal of experience in brokering highly leveraged trades for retail customers.
Who is the target group? Is this new generation just targeting smaller to midsize banks, proprietary trading firms, asset managers and hedge funds, CTAs/CPOs, or active retail traders? Are they also targeting the larger Multi- National Corporations (MNCs) and buyside institutions?
The target market varies between prime-of-primes. We’ve seen a market that is deep enough to see prime-of-primes that cater almost exclusively to the retail trading sector, but they are also becoming increasingly competitive in the institutional space, especially when it comes to providing liquidity to companies and asset managers who fall into that dropoff I just mentioned. As for the larger MNCs and buysides; they are usually adequately catered for by the main primes. We, however, are offering our services to everyone, and justifiably so. At certain volumes we’ve become incredibly competitive.
Do you see competition growing in this space? There have been some high profile exits of prime brokers but there have also been new entrants such as Saxo Bank and Forex Capital Markets? Do you think there is room for any more providers?
Many of the exits we’ve seen over the past few years, especially among the smaller primes, have had to do with increasing risk-appetites since the crisis, and a return to a “business as usual” mentality where hedge funds have cut costs by reducing the number of prime brokers they employ, whereas immediately after the crisis we saw that number increasing. It was always bound to happen, risk-appetites increase the further you move away from a crisis. A TABB Group study released a few years ago showed that the disaggregation we’ve seen in the wake of the crisis was already starting to reverse as early as 2010. As far as FX is concerned we’ve seen more and more options as to where to source liquidity from, and with retail trading continuing to grow, I think there’s a great deal more headroom in this sector.
How can the players differentiate themselves?
Simply by focusing on what they do best. It’s difficult to be all things to all people, but by honing your strengths and optimising every facet of your operations, I think significant value can be added. It’s very similar to all the good advice I’ve ever come across aimed at individual traders; find out what your edge is and work on that, if you can’t find your edge you probably have no business entering the game. Not to forget that the more primeof- primes we have competing, the better the overall level of service becomes. This is what’s truly exciting about the evolution of this sector. It is what led us to launch our own offering (FxPro Prime) in the first place. Almost all the pieces were in place, from the long-standing liquidity relationships to the experience and knowledge of the market. Acquiring the liquidity aggregator, Quotix was the last piece of the puzzle for us and we’re tremendously excited about entering the space.
What technology do they need to maintain and hone a cutting edge?
Again this is highly dependent on the nature of your business and the types of clients you’re targeting. Obviously latency is always a concern, but in our sector the degree to which you are able to offer a complete package, front-to-back-end, including trading platforms, riskmanagement, reporting software, connectivity solutions; all these are essential to helping you be more competitive by reducing the client’s operational costs.
Some buyside firms are sceptical about achieving best execution in FX. Is this unfair and what are the most optimal tools to improve execution?
I think it betrays a lack of understanding regarding just how much innovation is taking place. Any statement you make as to the quality of FX execution today is likely to already be out of date tomorrow. The technologies we now have at our disposal, thanks to our acquisition of Quotix, allow us to aggregate prices from multiple providers and consume liquidity in a far more efficient manner. As a result our clients receive better bid/ask prices than they would have if they were dealing with any one of our individual liquidity providers. These technological solutions to issues that are essentially hierarchical are why today’s prime-of-primes are becoming so competitive.
Looking ahead, what are the challenges and opportunities?
The challenges are primarily to do with risk. Prime-of-primes have to manage the risk of every entity they on-board. Additionally, the gearing provided to prime-of-prime clients is often higher. In the absence of sound risk management protocols this can be a recipe for disaster.
As great as these challenges are, I think the growth of the prime-of-prime sector is an extremely encouraging sign that our industry is maturing. More high quality liquidity can only be a good thing for all concerned, from institutions down to the individual retail trader.