Risk Management Moves Up The Prime-of-Prime Agenda
Number of platforms presents considerable challenges
Smaller institutions struggle to gain traction
In the second part of our two-part article on the prime-of-prime brokerage market, Paul Golden looks at whether it has become harder to manage risk across the growing number of platforms and examines the barriers to market entry for smaller institutions.
May 10, 2023 - The increasing number of trading platforms and technological advancements in trading have made risk management more complex. Brokers frequently encounter substantial market, credit, operational, and regulatory risks and effectively managing these risks is crucial for maintaining financial stability and achieving long term success in our industry.
For this reason, Andreas Kapsos, CEO of Match-Prime Liquidity says brokers should make an extra effort when it comes to risk management, which includes investing in advanced risk management technologies like automation tools and risk analytics platforms.
“An alternative approach to this problem is to use the services of an experienced technology provider that offers a full range of tools,” he says. “This approach has many advantages. Firstly, it minimises problems arising from connections between various providers, addressing the incompatibility issue. In addition, having a single point of contact streamlines communication, leading to faster response times and quicker resolution.”
If brokers can consolidate and have a back office on top of all platforms, it shouldn't be too difficult to manage risk across multiple platforms, but this is not always the case acknowledges Mohammad Isbeer, Global Head of Brokerage Sales for Equiti Group.
“The solution is to have a back office as the first layer and then connect all the different platforms, allowing brokers to normalise data and consolidate everything that will help manage risk, reporting, and finance,” he adds.
With more platforms, there is an increased risk of market fragmentation where liquidity is spread across multiple platforms. Different platforms may also have different rules, regulations, and practices for managing risk.
“The increased use of algorithmic trading and the growth of high frequency trading can add to the complexity of risk management,” explains Thomas Friesleben, Managing Director StoneX Pro EMEA. “These trading strategies can create rapid fluctuations in market conditions and liquidity, increasing the risk of sudden losses and unexpected market movements.”
According to Lars Holst, CEO & Founder of GCEX, it is important to note that risk management is an ongoing process that requires continuous monitoring and adaptation. As new platforms emerge - and market conditions change - it is therefore essential to review and adjust risk management strategies to ensure they remain effective.
Smaller institutions often struggle to achieve the same level of operational efficiency as larger, more established firms due to high up-front costs associated with technology, finance and accounting, and regulatory compliance. New entrants must make significant investments in human resources and technology in order to establish a secure and compliant platform, which can be a daunting task when trying to simultaneously generate revenues.
“Smaller institutions without a track record may struggle to access Tier-1 prime brokers at all, let alone on competitive commercial terms” - Gavin White, Invast Global
That is the view of Gavin White, CEO Invast Global, who says another major barrier is securing and maintaining Tier-1 banking relationships. “Smaller institutions without a track record may struggle to access Tier-1 prime brokers at all, let alone on competitive commercial terms,” he says.
Technology costs have decreased, but the reality is that market participation is now more complex and costly than a decade ago, especially if you add the time it takes to implement technology and connecting to third parties such as prime broker banks, liquidity providers, clients and IT vendors reckons Hormoz Faryar, Head of Institutional Sales at ADSS. “Smaller institutions may struggle to keep up with the complexity that is emerging,” he adds.
While these financial institutions face significant obstacles entering financial markets - such as limited capital, technology access, regulatory compliance, network effects, and counterparty risk - advanced trading technology and solutions are lowering barriers by providing streamlined workflow and broad liquidity pools suggests Aris Christoforou, Head of Regional Operations for Fortex.
“One of the most significant barriers is the high level of competition in the industry,” says Kapsos. “The FX market is extremely competitive with large and established institutions dominating. These institutions have the advantage of economies of scale, access to the latest technology, and established relationships with clients.”
Brand recognition can also be a barrier to entry for smaller institutions, he continues. “New companies must attract clients and getting a new customer is way more expensive than maintaining one. Building a strong brand reputation can take years and requires significant investment in marketing and advertising.”
Holst agrees that one of the main barriers to entry is the difficulty in obtaining a license in Tier-1 jurisdictions given that regulatory bodies have become more stringent in their requirements for obtaining a licence, and the process can be costly and time-consuming. Smaller institutions may struggle to meet these requirements, which can limit their ability to enter the market.
“Another significant barrier is the increased capital requirements that have gone up more or less across the globe,” he says. “Regulators require financial institutions to maintain higher levels of capital to ensure that they can meet their financial obligations and withstand market volatility.”
Smaller institutions may also face challenges in terms of their access to liquidity and technology. Larger firms typically have established relationships with liquidity providers and have invested in advanced technology, which can be costly for smaller institutions to replicate.
“However, with the right strategy and approach, smaller institutions can still compete in the market and achieve success,” he adds. “This may involve focusing on niche markets, leveraging technology to reduce costs, and building strong relationships with liquidity providers.”
Friesleben agrees that there are opportunities for smaller players to differentiate themselves by specialising in niche markets, developing unique trading strategies, or focusing on specific customer segments.
For a long time, clearing within prime brokerage has been dominated by large Tier-1 banks. This trend has reversed recently as prime banks reassessed their eligibility criteria for prime clients with the majority now focusing on large multi-asset accounts and in some cases, even withdrawing their services as they seek to manage their credit and risk management processes.
Justin Boulton, Head of FX Prime Brokerage at FXCM Pro notes that this has left a gap in the market for PoP services aimed at small-to-medium-sized non-bank financial institutions.
“There are numerous funds and institutions that trade a meaningful amount of volume but are not large enough to access prime brokerage services from the largest banks,” he says. “Platform agnostic prime-of-prime brokers address this gap by acting as a neutral intermediary for these institutions by providing direct, all-to-all market access to numerous execution venues through a single account. This leads to lower margin requirements, stronger risk management mechanisms, and frees up cash flow to be used in other operations.”
Read our first part of the review of the prime of prime brokerage market by clicking here: 'Prime of Prime Brokerage Market Requires Greater Clarity'
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