In the world of FX, significant changes are reshaping the market as we know it for hedge funds, broker dealers, and prime brokers (PB). According to a recent Acuti Report exploring some of the risks associated with PB consolidation, concern about the dependency on key providers remains high across the industry. The study states that a staggering 70% of hedge funds in this study are either very or quite concerned about the impact that the withdrawal of one or more of their FX PB providers from the market, would have on their business.
Over the past few years, there has undoubtedly been a notable shift as banks have either exited the PB business or become highly selective about the clients they serve. This situation has resulted in smaller funds and brokers experiencing the consequences of being excluded from conventional prime broker services.
As a result of this transformation, the concept of “Prime of Prime” has gained traction. Prime of Prime providers are stepping in to fill the void left by traditional bank prime brokers. While some have proven unsuccessful, others have performed better by extending their services to cater to the lower end of the hedge fund market.
The reasons behind this shift are multi-fold. Firstly, traditional bank prime brokers have set high minimum requirements, making it difficult for smaller players in the market to access their services. In an environment where many brokers are transitioning back to a warehousing model rather than offering a direct connection to market and liquidity providers, they are charging minimum service fees to extend credit lines and market access.
Prime of Prime liquidity providers typically charge higher service fees, yet their value becomes increasingly apparent as the FX market consolidates. These Prime of Primes offer the best means to access a diverse range of liquidity providers all in one place. This is especially significant for smaller players who may possess limited access to tier one liquidity and could be at risk of being offboarded by their prime broker.
Even large broker dealers, which you might not expect, are hedging their bets by engaging with multiple Prime of Prime providers. This diversification of their counterparties acts as a safety net should they find themselves offboarded by a bank prime broker. Establishing a bank prime broker relationship can take 6-12 months, while a Prime of Prime relationship can be established in a matter of weeks or months.
Following a period of waning influence of some years due to the easily accessible bank prime broker offerings, we are now witnessing the resurgence of Prime of Primes. Traditional players have been replaced by global names with strong balance sheets that can extend credit to the market. As a result, smaller hedge funds have increasingly turned to their services, as valuable allies.
However, as the risk increases for these remaining Prime of Primes, given their expanding client base, they need to ensure their pre-trade credit risk checks and post-trade automated hedging and reporting, not to mention poison risk management capabilities are the best-in-class. In an ever-fragmented technology vendor landscape, they require the right technology and connectivity to efficiently price clients and manage the diverse flows into one consolidated tech stack. This transformation is not limited to hedge funds alone. Broker dealers have embarked on a similar journey, although prime brokers initiated the off-boarding process of broker dealers much earlier.
The evolving FX landscape has unquestionably brought about significant changes in the prime broker business. The rise of Prime of Prime providers is reshaping the industry, offering a lifeline to smaller players and diversifying options for even the largest institutions. As the asset class continues to transform, the agility and adaptability of Prime of Primes will remain important for clients seeking a competitive edge in this ever-changing environment.
This article was published on Traders Magazine on 27 November 2023.
Tracey Kent is Head of Broker Dealer Sales, EMEA at MaxxTrader.