Why Does Liquidity Differ Between Prime of Primes?

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Why Does Liquidity Differ Between Prime of Primes?

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 funds 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 Primes (PoP), simply by the use of the word PRIME in their corporate name. The prospect concluded, that if all the FX liquidity providers are PoPs, wouldnt they all be sourcing the same bank liquidity, so, shouldnt all rates be uniform?

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 entitythe prime broker*.

Now, lets use thisdefinitionand 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 PoPs clients. Some key attributes and benefits of using a PoP would be:

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

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 Primes 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.

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 booths representatives all of thequestions a PoP should be able to answerat the snap of a finger. When he received replies that did not make sense or, my personal favorite, thats private company knowledge, we do not share that information with any anybody reply, then thats 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.

If you have questions or comments regarding this topic, pleasecontact us- We are always happy to help you!

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Notice Advanced Markets LTD holds Australian Financial Services License (AFSL) 444649 and only provides services to clients who meet the definition of wholesale client under the Corporations Act 2001. The Australian Securities and Investments Commission will not extend investor protections to clients receiving financial services outside of Australia. Please be aware that off-exchange foreign currency transactions carry a high degree of risk and are not suitable for many investors.

*Note: Advanced Markets does not accept any Non-ECP U.S. Accounts

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