How Prime of Primes and their clients choose a liquidity provider

Brokers would appear to be spoilt for choice when it comes to identifying potential liquidity providers. But as Paul Golden discovers, selection processes – and priorities - vary widely.

June 16, 2023 - When deciding where to source liquidity, a sensible starting point is ‘look before you leap’. As with any relationship, you don’t want to leave yourself exposed if things don’t work out.

“We have a number of different criteria when looking to add a prime brokerage or prime-of-prime to our panel,” explains Tal Dar, Vice President Institutional Sales at Vantage Connect. “These include pricing and execution speeds, the health of the liquidity partners’ balance sheet, safety of funds, and range of markets. The due diligence can take weeks as several departments are involved in the decision-making process, including risk and compliance.”

Rifat Sayim, Founder of GBE Prime adds the reputation and regulatory compliance of a liquidity provider, its trading platform and connectivity, and the variety of financial instruments offered to the selection criteria.

“The due diligence timeline includes conducting background checks, analysing financial statements, reviewing legal and compliance documentation, and negotiating terms and agreements,” he adds.

Quality of pricing and basic terms of business are always going to be important. However, for brokers going to the true primes, competitive pricing and terms are a given, so they now look at other areas, such as the efficiency with which they can receive and apply payments and withdrawals.

That is the view of Paul Groves, CEO of Europe at Finalto, who says a 24-hour, multilingual client services department gives clients confidence in their provider, along with an experienced liquidity team that actually understands their needs.

“It appears that for many brokers the first criterion when choosing an LP is their reputation and the industry relationships they have built,” says Andreas Kapsos, CEO Match-Prime Liquidity. “We also see how advantageous it is to always have contact with decision makers.”

Aggregation of LPs has obvious price advantages, but what is often overlooked are the possible impacts on price formation if one or more of the LPs in aggregation is slow to update pricing. This can be exacerbated if infrastructure or network routes are not optimised for the delivery of quote data in a timely manner. 

 

Gavin White, CEO 26 Degrees Global Markets

“Low latency quote delivery is something we expect from our LPs,” says Gavin White, CEO 26 Degrees Global Markets (recently rebranded from Invast Global). “Standard metrics such as response times and fill rates need be closely analysed. We perform sophisticated analysis of market impact to ensure poor performance of any single LP is not impacting execution quality for others and work with LPs that look to match orders natively in LD4, NY4 and TY3 to ensure our execution performance for clients is as strong as possible.”

GCEX has found that the optimal number of LPs to work with is between three and five. Working with less than three can create a heavy reliance on a single provider, while having more than five means certain providers receiving minimal flow - imbalances that can affect quality of service and competitiveness.

“Having a smaller number of LPs enables them to consistently win flow by expressing their interest, without being in fierce competition with a multitude of other players,” observes Lars Holst, CEO & Founder GCEX.

The firm’s selection process takes into account its experience working with these providers, ensuring that they have consistently demonstrated reliability and responsiveness even during times of market volatility.

“Another crucial aspect of our selection process is evaluating an LP's capacity to internalise a significant portion of the flow,” explains Michael Aagaard, Managing Director GCEX Denmark. “This ensures that they can effectively handle and process the volume of trades we execute, minimising the need to rely on external sources and streamlining the execution process for our clients.”

The extent to which brokers favour working with listed liquidity providers for reasons of transparency varies, with Tal Dar from Vantage suggesting this is less of a consideration than in the past.

“The biggest worry for a broker is safety of funds, which explains why they have traditionally chosen to go with a listed LP - even when they have to pay more to set up an agreement,” he says. “But many non-listed brokers with a healthy market share are just as well-funded and some may choose to segregate funds for their clients’ peace of mind even when it is not a regulatory requirement. They are also able to provide very competitive pricing that can match or even beat what listed LPs offer.”

Gavin White refers to the importance of adherence to the FX Global Code of conduct and the value of LP disclosure documents in the due diligence process.

However, Rifat Sayim from GBE Prime notes that brokers may still prefer working with listed providers as they are required to disclose their financial statements and reports to regulatory authorities and shareholders and are subject to stringent regulatory requirements and oversight.

“They also have obligations to their shareholders - including transparency in corporate governance and protection of shareholder rights - which demonstrate a commitment to ethical and responsible business practices,” he adds.

While it is expected that consolidation may occur in certain segments of the industry due to factors such as market evolution, regulatory changes, and shifts in client demands, GCEX anticipates minimal impact on the top liquidity providers.

According to Andreas Kapsos (Match-Prime Liquidity), stricter regulations and compliance requirements may make it challenging for some liquidity providers - particularly smaller ones with limited resources - to meet the new demands, significantly affecting their competitiveness.

“Additionally, as the market continues to evolve, customer expectations regarding quality and liquidity depth are increasing,” he says. “Established liquidity providers have an advantage as they can offer competitive pricing and access to diverse liquidity sources. Liquidity providers also need to invest in sophisticated trading systems and infrastructure and again, smaller liquidity providers may struggle to keep pace with these technological advancements.”

“As markets mature there will always be some level of consolidation, although I do not see massive changes in the near term,” says Paul Groves. “I think some of the smaller providers will fall by the wayside as the amount of capital required to sustain a liquidity provision business will only go up, but in general the main players will be around for some years yet.”

Gavin White also expects consolidation, specifically among the LPs that sit within large investment banks. “It is our view that the ability to innovate quickly and adapt technologies in a flexible way will be vital to ongoing success,” he concludes. “These are not characteristics generally ascribed to large institutions. Into this space will step a breed of new, technology-focused and agile non-bank LPs.”

Author

Paul Golden is a freelance financial writer covering the finance and professional services sector and many other related areas over the last 25 years, notably business technology.  You can message Paul directly here.