What is Prime Brokerage?
This article is intended to explain some important things about the work of prime brokerage in using the ECN Currenex platform. Most people may only know the meaning in general, while few have learned it specifically. You need to know that, there are many other nuances that are not yet clear at a glance. In this article, we will try to explain the ins and outs of the main broker. Our discussion will be based on Alpari’s point of view, which has undergone various processes, ranging from negotiation of the agreement to the introduction of the main broker that is full-fledged and the ECN’s own employment scheme.
First we begin with an introduction to the key players, which will be the center of the discussion in this article. Alpari has been in the business world since 1998, and is currently one of the leading providers of online trading services worldwide. In 2006, Alpari Group began a period of international expansion through ownership of Alpari Group companies with two main licenses, namely the license from the FSA for London-based Alpari, UK and a license from NFA for New York-based Alpari. Several offices were also opened in Shanghai, Dubai and in the world’s major financial routes.
Currenex is the world’s largest electronic trading system and is a recognized global leader in providing financial services to institutional investors. Currenex consists of large banks and brokerage companies among its partners.
Let’s look first at how Alpari arranged the steps in the “past”. In order to protect the value of client transactions, we open accounts with larger brokers, deposit money and protect the value of our clients’ transactions at the best price possible. But this system has many weaknesses, among them you have to open an account with different brokers, although in general this is not so difficult to do. Then you have to fund all your accounts, because you will never know what trading volume you need, on which account and which broker. Maybe you can move your funds between these accounts, but it is a waste of time and is not effective, and very slow. So, this issue becomes a serious concern in protecting the value of these transactions. The next problem arises, even though we managed to open a position at a good price, but for the next we have to close it through the same broker, and there is no guarantee that the price will be available at the closing position.
Financial markets in Europe and America are aware of the inefficiencies of this system and are starting to develop a new model called ” prime brokerage “. We take the example in England. We assume that there is a bank that is considered to be the main broker (generally only large banks, although some of them are Echelon II banks). Alpari goes to the bank to submit a prime brokerage account. Before opening an account, the bank first confirms whether the company has a license to offer brokerage services. And in our case, Alpari offices in the UK and US can show their licenses, respectively from the FSA and NFA. Apart from that, licenses from various enclaves and other unrecognized authorities will not be accepted here. This is the first filter and not all companies can pass it. Furthermore, the bank asks questions about the estimated trading volume targeted by the company, the bank will not be interested and will not open an account if the bank does not receive a very promising commission from the company. Companies with low trading volumes will be immediately rejected or their accounts will be closed as soon as possible when the company’s trading volume falls beyond expectations. Thus, trading volume becomes the second filter for each company, because this implies a large client base to achieve the required volume. Or in other words, we are talking about the volume of billions of dollars per month.
We illustrate the prime brokerage model as in scheme 1:
Alpari reached an agreement with the bank and opened a prime brokerage account. One of the conditions is that the account balance must not be less than 10 million dollars. Then the bank gives Alpari access to all major banks, namely liquidity providers.
We convey to our main brokerage bank that we want to conduct our trade through two banks, here we will call it Bank 1 and Bank 2. Both tripartite agreements ( three-way agreements ) were reached, namely between Alpari, Prime Broker (PB) and Bank 1, as well as between Alpari, Prime Broker (PB) and Bank 2. Furthermore, Alpari gets access to the trading terminal (if you want trading manually) or API ( Application Program Interface ) for automatic trading .
How is the transaction done? If Alpari sees a favorable price at Bank 2, then a request for a purchase ( request ) will be submitted. Bank 2 executes the request and confirms it to Alpari. Then Alpari sends the transaction records (filling in dates, volumes etc.) to the PB. Bank 2 also sends the notes to the PB. PB then compares transaction data that has been received from both parties. If everything is suitable, then the transaction is considered to have been fulfilled. After that, Alpari can see this transaction on its account in PB. Some percent of funds on Alpari accounts will be used as a margin for trading using leverage .
Next, we assume that we are ready to close positions and see Bank 1 has a more promising price. Alpari can close the transaction with Bank 1, but as before, the transaction must be confirmed first and then given ( given-up ) to the PB until it appears in Alpari’s ledger in PB. What is really happening is that Alpari has bought through its PB, not from Bank 2, while PB bought from Bank 2 and sold it to Alpari.
So, what makes the above scheme profitable for participants? The first and foremost is that PB gets a commission from the transaction (the amount of the commission depends on many factors including the volume of the trading company). PB can also deposit funds in Alpari accounts, which are intended to make a profit. For its role, Alpari has access to more banks, meaning to a more liquid market and can open and close its positions through different banks without having to move money through different accounts. Furthermore, Alpari can trade with PB without paying additional commissions. Banks 1 & 2 receive trading volume from PB without having to bear the risks associated with the trade (PB is a party that is directly related to market risk).
Thus, this scheme is beneficial for each broker, if the financial side and position are met.
Now we notice how Currenex works.
Many people already know what Currenex is and where the price comes from. There are various versions circulating about the actual Currenex explanation, some interpret it as an exchange . Actually, Currenex is a technology provider , they only provide access to an ECN through their servers and trading platforms.
Let’s see how it works gradually. Let’s say Alpari reaches an agreement with Currenex. Then Currenex contacts PB Alpari and connects the server so that it can confirm the transaction automatically to PB Alpari. Alpari then gives Currenex a complete list of banks, where the banks will be linked to the Currenex system.
Scheme 2 shows the working principle of this system:
Each bank provides quotations into the system in accordance with the FIX protocol. This quote is calculated from several different prices, depending on the volume.
For example, Bank 1 states that they are willing to buy 0 to 1 million EURUSD at the price of 1.5000 and sell it at the price of 1.5001 and are willing to buy 1 to 3 million EURUSD at the price of 1.4999 and sell it at the price of 1.5002.Because it is more difficult to shift large volumes, then for the amount of 3 to 10 million, the purchase price will remain at 1.4999, while the selling price will be higher, for example 1.5003. In other words, the bank will not provide a better price for a higher volume, because of the level of difficulty in processing large volumes. Conversely, smaller volumes will be much easier to process by banks internally. This is in sharp contrast to everyday life, where higher volumes will be sold at lower prices (discounts).
And of course, the higher the volume, the greater the risk that the bank will receive, thus forcing them to distribute these large volumes, for example to other banks. However, this tends to harm the bank because it can shift market prices against banks. So, a higher price arises for a larger volume. This model will remain the same everywhere, just as in large or small banks. The only difference is the level of risk. This also causes many brokers to charge a higher spread fee or offer execution with little profit for large orders. And it should be noted again, that if the broker does not do any of the above, then the order positions of the clients will not be hedged , giving rise to the perception that the clients’ profits are not guaranteed by the broker, or the broker will experience bankruptcy.
Therefore, the more banks involved, the higher the level of liquidity in a system and the price will be better for clients.
A broker who works using the scheme above will pay a commission consisting of two types, namely the prime broker commission and the Currenex commission. This commission is then forwarded to clients. As a rule in general, clients who work with Currenex will pay higher commissions, but can transact with lower spreads . While the company will pay a smaller commission because the volume consists of the total number of transactions of the clients. The difference between the amount paid by the company and the amount paid by the client is the company’s profit. Although the difference is not so big, but if the number of transactions (high volume) is more and more, then the amount of income that flows will be even more intense.
Therefore, brokers certainly really want the client’s trading to run successfully, the more clients trade , both in terms of volume and number of transactions, the greater the amount of commission the broker will get from the clients. In other words, the presence or presence of a client for a long period, will greatly benefit the broker. There is a similar note, that is, most traders with small capital will not last long in the market, so the income earned by the broker becomes lower.This is a stimulus for brokers to continue to improve their trading conditions and can explain why pockets of institutional clients are often offered small commissions and other more favorable conditions.
Moreover, prime brokerage and ECN models are proving themselves to be a reliable future deal. While the old patterns tend to cause unpleasant conflict between bro and clients, because clients accept ideal trading conditions, while the broker’s wallet will be drained more often. With prime brokerage , successful clients will avoid a threat, and become a permanent source of income for their brokers.
Indeed, not all brokers can meet the requirements to be able to use the broker’s work system which includes licensing, capital and a large number of client bases, and is able to generate a large trading turnover per month. Therefore, there are not many companies in the list of brokers working with Currenex, and the majority, second-tier brokerage groups do not have the opportunity to be able to register their names on the list. For this group of brokers, other options still remain, even though this method is less attractive, which is to establish a partnership with a broker who has worked with the main broker. But this requires an intermediary, and certainly will bring trading that is less profitable for clients.
I want to get rid of one myth about ECN, which is about the minimum trading volume. By default , Currenex sets the required volume, which is as much as 40,000 units of base currency. However, many banks are still willing to process orders with 1,000 units. We negotiated with our banks for a minimum volume of 10,000 units and requested that Currenex reduce its requirements to 10,000 units. Several transaction transactions with these parameters indicate that everything works for both the bank and Currenex. Going forward, we will most likely reduce the requested trading volume to this level for ECN clients. Given that currency transactions are run automatically (there is a “mini” forex on the interbank market), then the bank will not lose anything even though it works with a smaller volume.