With no standard definition of the term "Prime-of-Prime" there is a potential for misrepresentation. In the first of a two-part article on the prime-of-prime brokerage market, Paul Golden looks at the extent to which the term is open to interpretation, and why the liquidity and rates on offer van vary widely.
May 05, 2023 - In the first of a two-part article on the prime-of-prime brokerage market, Paul Golden looks at the extent to which the term is open to interpretation and why the liquidity and rates on offer van vary widely.
Prime-of-prime (PoP) brokers play a key role in the FX market as intermediaries between retail brokers and liquidity providers. But the importance of this role serves to highlight concerns around the absence of a standard definition of the term and therefore the potential for misrepresentation.
Every industry participant we spoke to agreed that this was an issue. For example, James Dewdney-Herbert, Senior Relationship Manager at Saxo UK observed that a PoP has to have a sufficient balance sheet and the business model has always been to act as conduit between Tier-1 liquidity providers and the broker’s downstream clients.
He suggests that if a broker chooses to use the term prime of prime and does not work with the largest counterparties, it is misrepresenting the nature of its business and probably the strength of its balance sheet.
According to Justin Boulton, Head of FX prime brokerage at FXCM Pro, while there is a misconception that the market is saturated there are actually only a handful of genuine PoPs.
“A real prime-of-prime is a neutral intermediary that offers a pure clearing solution with direct market access,” he says. “However, there are some which just offer liquidity and execution services but dress these up as prime-of-prime, which creates ambiguity these providers ultimately benefit from.”
The industry is evolving so quickly that it can be difficult to keep up with all the different providers and their business models. Staff movement and lax risk oversight has seen some established providers fall away while new ones with different models have emerged.
The Tier-1 investment banks are continuing to withdraw their services to the industry and the recent turmoil at Credit Suisse and in the US banking sector has only accelerated the pace of withdrawal, observes Gavin White, CEO Invast Global.
“This has resulted in a layering of the PoP industry beneath,” he says. “The top PoPs have invested in staff and technology to provide genuine alternatives for clients unable to secure a Tier-1 prime broker relationship, but those who have been unable to keep up have slipped to lower levels. We expect this stratification to continue evolving as the banks continue to withdraw in the face of tightening regulatory conditions.”
Not all PoPs are created equal, and some may have different business models, risk management practices, or levels of financial stability. If a broker is vague about what constitutes a PoP or cannot provide clear information about the PoPs it uses, this could indicate that the broker needs to be more transparent about its liquidity sources or risk management practices, which could ultimately impact the reliability and stability of its trading environment.
That is the view of Thomas Friesleben, Managing Director StoneX Pro EMEA, who notes that there can be significant disparities in terms of liquidity and rates between different PoPs in the FX market.
“Some may have relationships with a large number of Tier-1 banks, non-bank liquidity, and electronic communication networks (ECNs), which can allow them to offer deep liquidity and tight spreads,” he explains. “Others may have more limited relationships or rely on fewer liquidity providers, which could result in wider spreads or lower overall liquidity.”
For this reason, it is essential to carefully evaluate the liquidity and pricing offered by each PoP and choose a provider that offers the right combination of liquidity, rates, and risk management practices.
“The problem is complicated by the fact that there is no standard definition or regulatory requirement for what qualifies a financial institution as a PoP provider,” says Andreas Kapsos, CEO of Match-Prime Liquidity. “Therefore, traders must do their due diligence and research the reputation and credentials of any PoP provider a broker claims to use, checking their regulatory status, relationships with liquidity providers, and risk management practices.”
Significant disparities in liquidity and rates exist among PoPs in the FX market, with established providers with better access to liquidity providers offering clients tighter spreads, lower transaction costs, advanced technology, and risk management systems, while smaller or less established providers may have restricted access to liquidity providers, leading to limited pricing and execution quality, vulnerability to market volatility and counterparty risk, wider bid-ask spreads, and higher transaction costs notes Aris Christoforou, Head of Regional Operations for Fortex.
Geographic location, client base, and specific liquidity providers also impact a PoP's liquidity and rates, he adds.
Rates can vary depending upon the scale of the PoP and how much it needs to charge to cover its cost base, which is mainly a function of reliance on third party vendors, suggests Lars Holst, CEO & founder of GCEX.
“In other words, the larger and more established the prime-of-prime is, the more likely it is to have negotiated better rates with its liquidity providers,” he says. “On the other hand, smaller providers may have to charge higher rates to cover their operational costs. It is important to note that the quality of service and support provided can also impact the overall value proposition, so while rates are an important factor to consider they should not be the only determining factor.”
The quality of what brokers send out in the market also impacts rates explains Mohammad Isbeer, Global Head of Brokerage Sales for Equiti Group. “Being able to choose the right type of flow and send it to the right stream means that brokers get better rates and better stats,” he says. “The differences are not massive because underlying LPs are the same, but flow and liquidity management can differ.”
“Ultimately, the best way for brokers to assess the liquidity and rates offered by different PoPs is to conduct thorough research and compare their pricing and liquidity metrics against other providers in the market,” - Andreas Kapsos, Match-Prime Liquidity
Even among the largest and most reputable liquidity providers, there may be some variation in liquidity and rates as different providers may have different streams and pricing models. Moreover, some providers may offer a wider range of products than available elsewhere.
“Ultimately, the best way for brokers to assess the liquidity and rates offered by different PoPs is to conduct thorough research and compare their pricing and liquidity metrics against other providers in the market,” says Andreas Kapsos from Match-Prime Liquidity. “Technological background is also an important factor, and another important consideration that is often forgotten is how quickly business decisions are made.”
Rates are harder to determine, as the effective cost of trading should include parameters such as average spreads and slippage, and without the right tools it can be difficult for some clients to assess their effective cost of trading, especially when it comes to slippage.
“Overall though, the least expensive, tightest liquidity originates with the Tier-1 investment banks,” says Gavin White. “If a PoP does not have direct access to the Tier-1s then it is likely its liquidity and commercials will be inferior.”
Boulton suggests that the litmus test for finding a ‘true’ PoP is if it starts talking about its fill rates, spreads and latency times. “A real prime-of-prime doesn’t get involved in those discussions,” he concludes. “All it will do is give clients direct market access to a number of ECNs and counterparties.”
What are your thoughts on the definition of a "Prime of Prime"? Please feel welcome to add your thoughts in the comments below:
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