The epic world of Foreign Exchange Prime Brokerage has faced its biggest challenge since the demise of Lehman’s and AIG. In the current climate, PBs are raising the bar with credit, Basel III and onslaught of a low-volatile trading environment impacting the sector.
Ben Brown, Head of FX at Velocity Trade, a London regulated FX provider, shares his insight on the formidable topic of PBs and their young brother (that's getting a few inches taller!), the Prime of Prime (PoP) segment.
Before we get into the nitty-gritty, we asked Mr Brown his views on the current climate.
1) How is the current low Volatility impacting your business?
Unfortunately like everyone out there, volumes remain static to down. I think we may have fared better than most with volumes only really taking around a 10-15 percent hit, but that is largely due to the diversified nature of the customer base. That being said our corporate and institutional deliverable business continues to grow at rates in excess of 35% reflecting both the value we offer and our growing international capabilities.
2) No surprises there! lets move onto the world of Prime Broking, a recent influx of activity has shaken up the sector, namely at Rabobank & SEB but we’ve also seen some changes at BoAML, what's your thoughts?
I think it shows how costs and the pricing of risk has been somewhat incorrect and therefore was inevitable. The shakeout allows others to come to the fore and I think PoP and clearing services at our level remains a growth area.
3) It's interesting that you mention incorrect pricing, at banking institutes where there's modelling and forecasting for absolutely anything, we won't mention who was to blame! The PB offering has been around for a while, do you think the 2008 recession put FXPB in a turmoil?
In so far as the change in rules, coupled with a more recent and notable decline in volumes, the value of a PB relationship comes under more scrutiny from the provider. As for being in turmoil, I don't necessarily agree with that, last year's Dodd-Frank and this year's EMIR naturally slows things down and creates a little of the unknown and a therefore an extended period of stagnation. But as the Venerable Paul Weller once penned, 'This is the Modern World' and regulation has changed, no one PB is unique in this situation.
4) With bank and non-banking providers having similar offerings, in your opinion,what are the two most important things when searching for a PB?
In my personal opinion, Service and Support, it's a fairly basic equation, at the near end of the business' growth cost becomes less important (within reason). Primarily the questions we asked ourselves at Velocity Trade before choosing a provider were; 'how are we going to expand our business within the PBs framework and what support will we get in the expansion phases'?
Naturally that has a cost, it's all very well seeing sub 1 USD per million fees but what support do you get when initial monthly volumes are low? In the current FXPB world of agency, 4 way agreements messaging and risk, for Velocity Trade as a company to compete, we need to know that these often legally mired set ups are quick and precise, stagnation of this process creates a potential loss of revenue that at our level is more amplified than perhaps the potential loss of revenue at the PB
5) I was certain 4 way give ups were going to be mentioned! One customer segment that uses the services of PBs more than anyone are Hedge Funds, what are the challenges mid-size hedge funds and firms face when dealing with a PB?
Primarily, Risk and Value, the days of an open-book to multi-venues is diminishing, multi-venues being harder to manage on a risk basis and therefore costs rise, notwithstanding new core capital rules, Dodd-Frank and EMIR.
Tier-one PBs now look more closely at their deployment of capital and the inherent return on that capital. PB fees are in the ascendency making the barriers to entry harder for the smaller firms.
6) It seems that PBs are shutting their doors, unwillingly, so what's the alternative? PoPs?
I think there is a widening gap in the PB world created by the risk issues associated with multi-venue provision and simple value proposition,. Tier one PBs naturally have a greater watermark in terms of value. Prime Of Prime is a buzzword really for what has been created and provided by brokers like Velocity Trade for many years, providing access to venues such as Currenex, Hotspot, LiquidX and pools of bespoke Liquidity made up through internal and proprietary technology.
As the market evolves so the participants become more sophisticated and want the flexibility of managing their own liquidity relationships.
Ben Brown
7) Do you think it can survive as a product offering?
Yes, but there is still, perhaps, an element of realisation not yet fulfilled in the market. Costs are going up across the board, risk parameters are being tightened and access to multi-venues is being reviewed across the board.
That realisation only happens over a period of time, I refer to my earlier simple equation, the business model is built on slim profit margins and thus at the near end of the business cycle small profit, but PB is a long distance model. If we were to look at the rate at which participants move PB I would argue that it would show a fairly flat curve until maybe 2013 and that curve only being adjusted due to some Tier-1 PBs leaving the market and or tightening their risk parameters some of whom still sit in relative limbo. The key here is connectivity to venue and efficient messaging networks, but primarily again the support and service from your PB.
8) Well someone told me (in the pub, obviously!), It's not really prime unless you get connectivity directly to a Prime of Prime’s PB?
Here I must disagree, the essence of PB is simply a piggy backing of someone else's credit in order to access your chosen market. 15 years ago when FX was embryonic in its offering outside of the interbank world, banks were keen to provide a market price to a broker/dealer on the basis that the broker aggregated the flow 'up', from customers the banks simply could not access.
It's an evolution of the market, Prime of Prime is simply an aggregation of PB volumes 'up', where today's PB's higher barriers to entry prevent customers from accessing that market. We at Velocity Trade are fortunate that we have the support of our PB in this area.
9) Lucky number nine, will be the future.. where do you see the market heading?
Another forecast request? Like most economists I shall be professionally ambiguous here! I think you will see another one maybe two upper tier entries to the PB world. Volumes certainly have to grow in order to make that work. It looks like the issues around the FIX and subsequent proceedings have created an environment of fear and many simply want to see how that plays out before taking on more risk. Volatility needs to return and it will, as soon as the MPC starts to tighten monetary policy and I suspect in the nearer term both sides of the pond will ease off on QE which again should help volatility.
The world’s largest investment banks have been the pinnacle of the foreign exchange market, however with more and more scrutiny, challenges and difficulties to make money, the non-banking institutions are stepping up their game. The post regulatory world will dictate the role banks will play in a multi-venue marketplace.
