I thought it would be useful to compile a short list of the main differences found when trading OTC (over-the-counter) FX with an STP (Straight Through Processing / No Dealing Desk) “Prime of Prime” and a Retail brokerage.
The differences can be categorized as follows:- Vetting / Onboarding
- Netting vs Hedging
Vetting / Onboarding
The vetting of an individual or corporation, for FYC and AML purposes, should generally be the same whichever venue is chosen, with variations depending upon the country that the brokerage is regulated in. With that said, some differences can occur:
Retail - Most, but certainly not all, retail brokers deal with individual clients and use MT4 as their platform of choice. Once a prospective individual client completes and account application, using either an automated system or a live salesperson, an MT4 account can be created and assigned immediately. The compliance process is then initiated. The standard documentation required for the vetting of a retail individual is a standard valid photo ID and Proof of Residence. Once those requirements have been satisfied, and the client’s funds clear and hit the broker’s account, then the broker would apply the deposit to the MT4 manager and the client could begin trading immediately.
Wholesale – When a person/firm initially seeks classification as a wholesale client then the process will generally involve a discussion with a live salesperson who would look to understand the client’s set up to determine if they the can be deemed wholesale under a whatever regulatory jurisdiction is chosen. Normally the client will be a corporation with varying owners and structures. The broker’s compliance department will require all corporate documents, such as articles of incorporation, along with the personal vetting of each owner to include their proof of residence.
The configuration process with a true wholesale PoP (Prime of Prime) brokerage is a bit more involved than the standard MT4 set up. Once the client passes compliance and the money has arrived in the wholesale brokerage’s bank account then the work can begin. The client’s deposit will be used as collateral for their trading activities. An onboarding, or configuration, team will create an account in the back office and map it (connect it) to either a pricing aggregator, front-end platform/GUI or FIX API. Once all of this is in place, the set up would be tested to make sure that all the moving parts were working before the client could go live.
Netting vs Hedging
Retail – Most retail brokers use Metatrader, MT4 as their platform of choice. The MT4 front-end allows for the hedging of trades (where a client can have a LONG and a SHORT position open in the same currency pair at the same time) and also gives the ability for client trades to be closed in whatever order a client chooses. The ticket hedging function itself allows the retail broker to assign swaps (overnight financing) on the both the LONG and SHORT positions that are open.
Wholesale – A wholesale brokerage could offer MT4 as a front-end platform option but would use their own robust back office technology to maintain all of their client equity and positions as the TRUE statement of record. Although a client would have the ability to both hedge positions and to close trades in whatever order they choose on MT4, the wholesale brokerage’s back office engine would treat these trades very differently. For example, whilst a client could have a Long EUR100,000 position open alongside a SHORT EUR100,000 position on their MT4 GUI, the brokerage’s back office would show them with NO position, they would be flat. This is due to the fact that the client’s position is NETTED in the back office. By the way, it’s important to note that the overnight swaps are determined upon the net position. Another significant difference between both is that the back office applies the standard interbank (and regulatory standard) FIFO rule (first in first out) to all trades. As an example, say a client buys 10 separate amounts of EURUSD 100,000 during the course of a day and then decides to place 3 sell trades of EURUSD 100,000 each. On MT4 they could choose which of their 10 buy trades to close out with their 3 sells but the brokerage back office (the true statement of account) would apply the first sell to the first buy (in time order), the second sell to the second buy and so forth.
Retail – Depending upon a client’s country of residence, the approximate average total deposit through the lifetime of an individual retail account varies between $3-15K, with the client adding deposits in small increments. Retail brokers are willing to accept deposits in varying ways: bank wire, credit card, and through online payment providers. As an aside, the credit card and online payment provider will generally charge 2% on the deposit amount.
Wholesale – In the first place, to be classified as wholesale, some regulatory jurisdictions require an initial deposit to be in the range $250K to $500K, but regardless of that requirement, wholesale client deposits tend to be much larger than those found in the retail space. Given the amounts involved and the regulatory restrictions, wholesale clients tend to send funds via a wire transfer.
Retail – Retail brokers, using MT4, will either choose to operate a B-Book model, where they take the other side of the client trade and warehouse the risk in-house, or an STP model where every client trade is sent straight through to the market for execution. In the B-Book model the prices shown are being generated by the broker themselves rather than directly from the market. I should add here that some brokers operate a hybrid model where they will hold some risk in-house and pass the rest to the market. Any retail broker can STP (send trades directly through) to the primary market (the banks) as long as they have access to a Prime Broker, or Prime of Prime, to facilitate those orders.
Wholesale – Some wholesale brokerages also choose to operate Hybrid B-Book/STP models whilst giving the perception that they are fully STP. In that regard, potential clients should definitely do their due diligence before deciding on which broker to deal with. A true wholesale broker, or Prime of Prime for that matter, would operate a fully transparent STP model with multiple bank, and non-bank, Liquidity providers aggregated to maintain tight consistent spreads and fills. All client orders are sent to the market for execution, no exceptions. For those clients unable to acquire a direct prime brokerage relationship with a tier 1 bank, this “true” prime of prime is definitely the next best thing.