iFX EXPO 2017 organizers recently published videos from seminars happening during the conference in main hall.

One of the panels was particularly interesting because two prime of prime brokers and one tier 1 prime broker were discussing matters related to liquidity provision for retail brokers.

I understand that in this moment you can have 3 questions, which I will answer briefly below:

  1. What is “tier 1 prime broker”?
  2. What is prime of prime?
  3. As retail trader, why should I care about liquidity?

Prime broker – it is a broker which provides liquidity to institutional traders and brokers. Usually these are banks (especially investment ones) where transactions are made by investment funds, insurance companies, corporate clients etc. Prime brokers are grouped by tiers (1, 2, 3 etc.) where Tier 1 are the biggest banks with direct connection with interbank market.

Prime of prime – because everything depends on the size and scale and prime brokers usually do business just with huge and well known institutions, retail market need some kind of “adapter” to reduce capital requirements and size of minimal transaction. Prime of prime is a solution for smaller brokers, small funds and tiny money managers who cannot afford cooperation with prime brokers (usually these are private companies, so-called non-bank LPs).

Retail traders – why should they care? We know that whatever happens in Brussels in terms of regulations, it affects the whole EU. The same situation is with liquidity in FX which has impact on brokers and therefore indirectly on us. Because of that, it is crucial for retail trader to know, how the market looks like if we are about to invest a lot of money on it.

Few bullet points of the panel

  1. Less [liquidity providers] means more.
  2. High Frequency Trading and aggressive trading
  3. Prime brokers “tag” clients
  4. Profitable broker clients and their transactions (so called toxic flow)
  5. Last look for transactions and the right to reject it
  6. ‘Superior force’ events like SNB interest rates decision or flash crash on Sterling

It’s (usually) better when broker has less liquidity providers but has good relations with them, because then he has chances for better spreads and execution. When broker has many LP’s but doesn’t send significant volume to any of them, he will be treated with no favors. Broker business is strongly about relations, we as retail traders opening positions via online platforms have not used to it. In front of a computer it looks like opening position is no different from sending messages on a chat, while what happens behind the courtain is totally different.

Aggressive trading (scalping?) and High Frequency Trading is a stream of orders really hard to manage by liquidity providers.  It’s not appreciated by brokers and LP’s because it’s hard to protect/hedge it on the real market. Prime of primes representatives said that they do not take any risk associated with clients’ positions, and they just process all of the orders further, so the receivers (prime brokers, LPs) and their technology need to be able to process influx of those orders in short time.

Prime brokers tag clients and analyse their liquidity. Of course they don’t see individual accounts of individual retail brokers’ clients but they analyse quality of volume coming from each and every broker using their liquidity and doing vols with them.

Toxic flow. As mentioned above, prome brokers tag clients and analyse volume in longer term. In this place a debate host, who successfully trades with use of algorithms, said that brokers don’t let him to exceed certain volume with his transactions. Prime brokers (like NatWest/RBS) look mainly at a profit/loss of a broker or prime of prime and determine whether they want to have this kind of “flow”. The conclusion is – if you make money, you will be allowed to make it on a small scale.

Last look means that liquidity provider has up to ~200 ms to decide whether it will accept or reject the order. Some regulators consider this as illegal or claim that it should not be legal. On the other side, for LP’s it is a method of protecting his business which is mainly (especially when comes to prime brokers) about “market making”. According to panellists, without the last look spreads would be much wider because liquidity providers would expect higher premium for bigger risk. However, if subsequent LP’s keep rejecting a particular order, the execution is delayed and experence slippage. It’s also worth mentioning that more and more companies offer execution without the last look, so traders and brokers can decide where to send their transactions as they have choice now.

Trading industry has learned a lot after events like abandoning EURCHF peg by SNB. After this event technology has been improved and changes were made in liquidity control. Thanks to that the recent flash crash on Sterling wasn’t really harmful for retail sector.

Another interesting speech was one delivered by CySEC president – Demetra Kalegou:

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