Recently at an FX conference, a developing fund manager and I crossed paths. After a few polite introductions, I quickly realized that, based on his audited returns, the new fund manager was proficient in trading the FX market. The detailed description of the fund’s fundamental and technical trading strategies was welcoming to hear.
After a few routine questions from the prospective client, the topic promptly turned to spreads and liquidity (my favorite). The fund manager was comparing pricing between FX brokers and asked why spreads are so contrasting amidst all of the firms in question.
We took a stroll around FX expo floor, looking at the different booths and it became apparent that the industry is becoming chock full of Prime of Prime’s (PoP), simply by the use of the word “PRIME” in their corporate name. The prospect concluded, that if all the FX liquidity providers are PoP’s, wouldn’t they all be sourcing the same bank liquidity, so, shouldn’t all rates be uniform?
What is a Prime of Prime Broker?
I explained that when an FX liquidity provider claims to be a Prime of Prime in the FX industry, they are making the claim of enormous stature. The New York Fed defines a Prime Broker as follows;
“Foreign exchange prime brokerage allows a client to source liquidity from a variety of executing dealers while maintaining a credit relationship, placing collateral, and settling with a single entity—the prime broker”*.
Now, let’s use this definition and make clear what a “Prime of Prime broker” (PoP) is. A Prime of Prime is a broker who retains and uses the services of a Tier 1 Prime Broker to facilitate trading conditions, which can be extended and used, by the PoP’s clients. Some key attributes and benefits of using a PoP would be:
- Secure a Top Tier PB credit facility
- Access to aggregated bank-sourced liquidity via an Equinix or verified Tier 1 datacenter
- Potentially receive greater leverage than that offered by the Prime Broker itself
- Provides all counterparties, post trade
- Credit and margin accounts available
- Triparty Custody Accounts available
So, we continued our walk from one glamerous booth to the next, observing all the “pure STP” promises and flashing lights emulating from the jumbo screens of streaming FX rates the “Prime’s” so eloquently displayed. One after another, the rates differed from broker to broker and the client could not help but notice that something seemed off…
I provided a few reasonable answers on why we would be seeing all these discrepancies ranging from: different banks; various bank feeds; hybrid models (A and B Book); aggressive markup tiers; etc.
How to find a true Prime of Prime
Then the enlightened fund manager challenged me, “how do we even know if they are a Prime of Prime anyway?” What could I do?
I had no other choice. The biggest non secret in FX is out of the bag.
I offered a bit of advice on how to figure out if you are dealing with a real PoP and bank liquidity, or just a marketing scheme to access institutional clients. With this new-found critical information, the fund manager would boldly ask each booth’s representatives all of the questions a PoP should be able to answer at the snap of a finger. When he received replies that did not make sense or, my personal favorite, “that’s private company knowledge, we do not share that information with any anybody” reply, then that’s when this client had his AH-HA moment.
I took this experience with me, and created an audit of sorts, “Review your Liquidity Provider” to help the FX marketplace understand who exactly is your broker, who are you actually dealing with. This audit will serve as a guide of sorts to gauge whether your broker is a true Prime of Prime or an imposter.
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