“True Prime of Prime” adds no value at all
When I sat on a panel at the FX Week conference in London alongside representatives from industry peers, we were all asked “how does the cost of your service compare to the cost of a Tier 1 PB?” The response of our peers was unanimous and astonishing, all of them stating that their service will be “a little more expensive” than a Tier 1 PB.
My answer was different, total transaction costs will generally be lower with IS Prime than with a Tier 1 PB, because average transaction spreads will be better, and commissions will be similar.
It is worth exploring this topic, as it seems confusing that a company would voluntarily admit that their service is worse or more expensive than an alternative. This subject goes to the very heart of “Prime of Prime”, so we should start by defining this often used, yet poorly understood term.
“True Prime of Prime”
The term “Prime of Prime” is a useful catch all to categorise firms who offer Institutional FX services on a matched principal, or 'STP', basis, and in turn access the wholesale markets via a Tier 1 Bank PB or direct credit. A “True Prime of Prime” is a more specific term, as it represents a firm that operates a model where they offer a pure credit intermediation service between their clients and their LPs.
There is a lot of marketing smoke and mirrors in this tier of the industry, with many firms claiming to be something that they are not. Only a few of the firms that are slapping the “True Prime of Prime” badge of honour on their own shoulders actually do offer this service.
These firms have increasingly been actively marketing themselves as a “True Prime of Prime”. FXCM’s Head of FX Prime Brokerage, Justin Boulton expanded on this point recently in a Euromoney Article and Peter Plester, Head of FX Prime Brokerage at Saxo Bank has made the same point on the aforementioned panel and also in PR news releases.
Why promote the fact that you add no value?
To refer back to the panel above, the “True Prime of Prime” service is the broker re-selling (a heavily watered down version of) their PB’s service, at a premium. This means that they are simple re-sellers, not doing anything smart, not providing any bells or whistles…adding no value.
Furthermore, with Citi publicly scaling back their FXPB being the latest example, the FX PB model has been repeatedly proven to be challenging, even for the major banks. The SNB event in particular demonstrated that the risk return dynamics of this business are challenging. How is it sensible business practice therefore to offer this service with the same (or greater) inherent risk, at a lower profit margin.
Why are our competition inadvertently stating so publicly that their service provides no value add? The implication is that every one of their clients should aspire to disintermediating them by going to a tier 1 PB.
The only logical reason for this can be that they do actually have nothing to offer other than re-selling their PB relationship. Most of our competitors simply use licensed 3rd party technology in a low touch, predominantly “one size fits all” solution. As far as I’m aware, there hasn’t been meaningful investment in value add proprietary technology to analyse and manage pricing, liquidity and flow.
Finally, giving end clients control of bank liquidity relationships seems like a nice idea, but it doesn’t mean that the LPs will price more competitively direct to the end client and additionally there is often no actual legal contractual relationship between client and bank in a True PoP set up, which in my view, is an accident waiting to happen.
Do Bank LPs really want to provide a feed to every end client?
The reality is that most major LPs would prefer to face fewer clients who trade larger volume, and would prefer not to face every end client directly. This is simply because major LPs have significant infrastructure costs, which mean that every new API or price feed that they produce has an implicit cost to them.
They also have significant support costs, as they have to have sales and trading resources to manage every individual client relationship. In an environment where there is a significant drive among the large investment banks to be as lean as possible by reducing their costs, this is a meaningful dynamic.
The sobering reality is that it only really makes sense for an LP to price a client directly if they can charge you wider spreads for the same flow. This means that if your wholesaler is managing liquidity properly, they should be able to provide you with better spreads than you could get with direct access through a secondary prime arrangement.
IS Prime is a Liquidity Provider, not a Secondary Prime
In considering the above, we do not want IS Prime to be seen as a “True Prime of Prime”. IS Prime’s product is absolutely liquidity first, and clearing second. We believe that we devote more expertise and resources into liquidity analysis, market impact analysis and general liquidity optimization than any of our peers. This is the direct feedback that we get from our Liquidity Providers, some of whom have explicitly stated to us that they would prefer to face an end client through us than to service them directly through a secondary Prime.
We are very proactive in liquidity management; the fact that our peers actively advertise that their offering is a clearing service means that they believe liquidity to be commoditized and simply shove everything down to the LP’s. They are then reactive (to the detriment of their client’s pricing) when the LP’s identify challenging flow.
The value add is in the quality of the liquidity that we are able to offer, and the clearing / credit side of things is absolutely secondary; the easy part that anybody with a balance sheet can do. IS Prime do not offer a credit intermediation service, nor is it our intention to do so. “True Prime of Prime” is a business model that represents no value add, a poor return on risk and a poor use of balance sheet.
It could be stated that IS Prime is therefore not a “True Prime of Prime”, and we would not argue this point. Our peers outsource their balance sheet, we outsource our balance sheet, our critical mass of flow, and our expertise backed by significant technology investment.
We are a Liquidity Provider with an additional Prime clearing service; put another way, we offer a Prime of Prime service with a genuine value add.