FX prime brokerage
|
Prime Brokerage Anatomy™
|
FX prime brokerage enables customers to trade FX swaps with executing brokers in the market without needing to be set up with credit lines with all brokers. Instead, the customer sets up lines with a single FX prime broker and then uses that firm’s existing trading network and credit relationships to access liquidity in the market. As with other PB relationships, one major advantage to customers of FX PB is speed to market and counterparty management: a customer only needs to put in place full ISDA documentation with its own prime broker; all the other trading arrangements are between the prime broker and other executing brokers, and are long-established.
For their part, EBs don’t need to worry about the customer’s creditworthiness as long as it stays within trading parameters pre-agreed with the PB: legally, the EB faces the PB at all times and not the customer. The PB extents credit to the customer and assumes all its credit risk: this is what ~ cough ~ PBs are good at.
Trading Mechanics
Like all swap-based prime brokerage arrangements, PB depends on give ups: the customer trades directly with a network of executing brokers, all of whom give up the trades to the prime brokerage.
FX PB is unique in that the give-up works through inverted agency: the customer acts as the prime broker’s agent when placing trades with executing brokers. This is weird aberration in the natural order of things in the capital markets: usually, a broker acts as agent for its client, and not vice versa.[1]
That said, it is a neat and efficient way of transacting. The “give-up” isn’t a give-up in a true sense: rather it is an automatic intermediation: the customer acts as the PB’s agent when it trades an FX swap with an executing broker and, by doing so, automatically creates an equal and off-setting FX swap transaction between the PB and the customer itself. The PB becomes is a principal counterparty to both swaps.
While if the customer trades outside its agreed mandate a PB could DK the trade, it rarely does so: as with other give-up arrangements in liquid markets, it is quicker and easier to just immediately unwinds the trade and pass on the gains or losses to the customer.
FX prime brokerage mainly deals with FX swaps and forwards, where there is a credit risk component and the customer wants financing. It is less crucial for spot FX, which settles DVP settlement through CLS[2] though customers still use it for spot transactions for operational efficiency.
Benefits for customers and the market include the simplification of trading and credit arrangements, better pricing for customers who flex their PB’s market relationships, consolidated operations and reporting and all-important market anonymity.
See also
References
- ↑ One other place you see it is in direct electronic access arrangements in equity brokerage, although here the market has no idea it is the customer behind the veil pulling the broker’s levers.
- ↑ “Continuous Linked Settlement” is a global FX settlement system that eliminates settlement risk through a simultaneous multi-currency payment-vs-payment (PvP) mechanism, where settlement members (major banks) provide liquidity at fixed settlement times during each trading day.