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F X P R I M E B R O K E R A G E

T

he phenomenal growth in FX prime brokerage in just five years, fuelled by

a big question about the viability of the FX prime brokerage offering as less than 1% of the daily dealer to client volume was FX prime brokerage. Fast forward five years and every major participant in the market is offering FX prime brokerage and now we estimate that a quarter of the daily volume is FX prime brokerage."

Importance of Hedge Funds

Cross-asset prime brokerage

Cross-asset capabilities are the core of JPMorgan's prime brokerage offering. Almost three years ago, all prime brokerage services were brought together in a single platform covering FX, interest rate and credit derivatives, commodities, and securities. Even more ambitious was the firm's decision to run the business as a single global unit, with 24 hour coverage across North America, Europe, and Asia.

the transformation of the FX market by electronic trading and the increased liquidity provided by FX ECNs, is very much down to the hedge funds and the simple fact that FX is now traded as an asset class in its own right. While there is no doubt that banks sold prime brokerage in the early days in order to boost FX volumes and increase margins, today, the focus has very much changed and it is not FX margins they are chasing so much as the bigger prize of a guaranteed revenue stream by processing as a prime broker. The pitch has also changed. In the early days FX prime brokerage was a heavily manual process with no standards for give-ups agreements and FX prime brokers had to invest in staff. Today, the pitch is very much about connectivity, market access and the greater efficiency gained through automation and straight through processing and commitment is measured in technology investment.

According to Mandelzis the growth has been driven by hedge fund participation, and the fact that hedge funds started trading FX as an asset class. Then the erevolution, both in terms of the banks that have invested in e-commerce, pricestreaming capabilities for their own single bank portals, as well as massive growth in the ECN activity added to this. He says:

"As a lot of the ECNs require a prime broker to participate this pushed the market even more. The entry of a new breed of traders ­ the algorithmic traders, further drove FX prime brokerage.

Dave Olsen

Automating and bringing processing costs down have been key and are even more important now as competition has increased and influenced the margins and the pricing."

He also thinks that further growth will come from prime brokers offering prime brokerage to other kinds of clients such as traditional fund managers and money managers, which will escalate over the new few years.

Gil Mandelzis

Dave Olsen, global head of prime brokerage marketing at JPMorgan says:

"Based on feedback from our clients, we decided to create a single business line for prime brokerage across all traditional boundaries. For many hedge funds, FX prime brokerage is becoming increasingly linked with other liquid markets, particularly interest rate derivatives, government bonds, and related futures contracts; our ability to intermediate these risks and support them with a single team is a key element of value in our relationship."

Olsen believes that another compelling element of JPMorgan's strategy is its development of risk-based margining. If a

By Frances Maquire

Frances Maquire

FX prime brokerage as a mainstream service has expanded beyond the hedge fund world to embrace all client types who are recognising the benefits it can bring to their business. It's recently become an increasingly competitive arena, with clients demanding more effective reporting, increased account control and robust automation, finding it harder to differentiate amongst providers.

But for now, Mandelzis says that banks Gil Mandelzis, CEO of Traiana, says: "Four are trying to differentiate by extending services to smaller funds and offering back office processing and hedge fund administration to add value as well as investing in sophisticated reporting to the larger funds.

or five years ago, the genesis of modern FX prime brokerage, it was a niche service provided to a very select number of clients. It was a very manual, high-touch process, with few players. There was even

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Raising the bar - what's prompting change in the foreign exchange Prime Brokerage business?

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client has FX, interest rate derivatives, government repo, or futures exposures, JPMorgan pulls all risks into the same model to determine the correct amount of margin to collect on the portfolio based on the inherent offsets that might exist across markets. For clients that are more focused on pure FX strategies, JPMorgan is betting its best-in-class technology will help them continue to gain share in a competitive market. Says Olsen:

Many funds that had previously focused on single strategies are expanding their footprint in the market to include FX as part of a multi-strat profile. The liquidity and transparency provided by the ECNs has also fuelled growth in the FX market, he adds.

Focus on differentiation

closely at the understanding of, and commitment to, the sector as it is imperative that a prime broker cannot only support existing requirements, but is committed to staying on the leading edge of innovation. For example, says Duff,

"The additional electronic access points along with expansion into additional asset classes have provided ample opportunity for prime brokers to differentiate in a market space considered

Brian Duff

Prime broker, RBS Greenwich Capital, currently supports FX, interest rate derivatives and futures under a single umbrella while actively engaging in expanding capabilities to credit derivatives and other over the counter (OTC) products, and has built a strong quantitative research and an advisory service on technical set-up and support. Brian Duff, head of prime brokerage,

"This business is

by many to be commoditised."

He also adds that technology and

about scale, not only to meet the capacity demands of our clients, but also to put us in a position to be a low-cost provider. The advantages of a straight through processing model are multiple: we can process higher volumes with less operational risk at a lower marginal cost."

In the past year, JPMorgan has rolled out a number of products that provide true real-time reconciliation for FX so clients know exactly what their position is as well as the P&L they have generated to that precise moment. Olsen says "A lot of our

technical nuances of the available ECN's and liquidity pools. We don't just plug-in clients but work to establish highly efficient solutions for each client. In addition to technical expertise, we are focused on understanding each client's strategies in order to advise the alternatives best suited to the clients needs. This expertise comes from the substantial experience of the members of our prime brokerage team."

automation, capital efficiencies, crossmargining, and a high level of

it has an extensive balance sheet with the ability to provide credit lines to facilitate trading via any counterparties or channels, the ability to be a wholesale trading, settlement and clearing provider for clients and banks, as well as continued investment in technology and high quality global service personnel."

technologies and workflows. Releases are scheduled every quarter and future releases will add new reports and distribution mechanisms, continued enhancements to its give-up straight through processes and new services for post trade management and position rolling.

responsiveness are always in demand from prime brokerage clients, and while most managers do have strong interest in capital introductions, if the prime brokerage product and service is not of a high standard, it is not sustainable. Likewise, while algorithmic trading has had a major impact on the FXPB space and the

North America, at RBS Greenwich Capital, says: "Our focus on differentiation is

geared

towards

automation,

capital

efficiency, and customer service. It is paramount to have 24-hour, global inhouse technical expertise and support. We are also highly focused on the

Says Graham: "UBS is leading the way in

Duff believes that clients assessing a prime brokerage offering should look

subsequent volume explosion on rate compression, regardless of the rate, the business is not sustainable without

offering prime brokerage across asset classes. We work with our clients to provide them with the exact level of crossproduct facilities they require. Capital introduction continues to be important as investors seek to increase exposure to FX as an asset class, but currently clients seem to be most focused on efficiency gains, operational risk reduction and cost controls. We have worked with our clients

Devin Graham

clients have embraced this technology to ensure they are never out of sync with what we believe their position to be. Control and confidence are paramount to all clients, but especially to the algorithmic traders. Because of the sophistication and speed of their models, mistakes can have severe consequences, and our ability to provide immediate reconciliation 24 hours a day means our clients can mitigate any errors at their point of origin."

Olsen is in no doubt that the biggest driver of growth for FX prime brokerage has been the increasing number of funds developing FX as a strategy, not just a support function for other global activity.

significant capabilities. According to Duff

"Further growth in our FX prime brokerage will come from both leveraging our existing capabilities, and staff and will additional always be products, the key services and technology. In-house expertise differentiator in prime brokerage offerings."

Selecting a provider.

to significantly automate their trading, clearing and reconciliation process. As a result clients know their up to the minute portfolio exposure and can reduce the manual overhead associated with trade processing."

He believes there are a great number of growth opportunities for FXPB services,

Devin Graham, head of FX prime brokerage at UBS, says: "First and foremost a client

All of UBS's FX prime brokerage services are developed in house and constantly enhanced in line with clients' requests. Recently UBS has made a variety of enhancements to its reporting services as well as expanding its give-up services to support a wider variety of client

must realise they are not just selecting a provider but they are selecting a partner and as such, a partner must be evaluated on its demonstrated commitment to being a market leading liquidity provider, whether

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as more and more clients are starting to realise the benefit of utilising prime brokerage services and processes. While hedge fund activity continues to increase, other markets are opening up. However, Graham believes that competition is increased and that only the prime brokers that have sound scalable services now are in the position to invest to offer services to this growing market.

The improved straight through processing frees up prime brokers to focus on bespoke services as well as enabling Citigroup to better service clients, simply due to the fact that the faster trades are given-up, the better the position the prime broker is in the reduce the client's market risk exposure. Says Coyne: "Each client is

operational and market risk. Clients are always presenting new challenges to us, so there is never a lack of opportunity to differentiate ourselves."

Penson's Quantitative Execution Group offers international multi-asset, multicurrency, algorithm advisory and execution services together with our multi-asset, multi-currency custody and clearing services. It can enable crossproduct margining of equities, options, and bonds and has capabilities to offer cross-risk management of futures. It also plans to offer premium alpha research to select customers. Says Slade: "It appears as if continued

different. There are some clients that this is simple enough and electronic enough that it is fed into the service, although we have great many clients who have complex clients and what we are doing with them is managing their potential market risk exposure and what we do is critical to making sure that their trades are matched and handled correctly."

According to Coyne, algorithmic trading has grown on the back of FX e-commerce and has taken off because prime brokerage allows access to any given liquidity pool. For Roger Allen, director of foreign exchange prime brokerage at Dresdner Kleinwort, the fact that its FX prime brokerage service has been built by its own IT developers, in response to client requests, has given Dresdner Kleinwort the flexibility to develop bespoke services as there are no legacy systems restricting its flexibility. He says: "We are constantly improving our

Roger Allen

competition and regulation in the equity markets has generated buy-side interest in

The same IT development team has built Dresdner Kleinwort's full cross-product, cross-margining prime brokerage system so that there is true compatibility for multiDeveloping bespoke services

The recent moves in FX prime brokerage is prompting Penson, a full service firm for multi-asset, clearing, multi-currency custody and international

more lightly-regulated asset classes and in less-regulated countries both of which play into Penson's current offering. Our vision is to create a premier global multiasset, multi-currency execution, prime brokerage, clearing and custody firm. We have made significant strides in seeking that goal and hope to leverage our technology prowess and customer service to win large institutional customers who demand a higher level of service."

Conclusion

asset class clients facilitating efficient collateral management. This enables Dresdner Kleinwort to offer full crossproduct, cross-margining capability and reporting. Says Allen: "We offer all-in pricing for PB

trading to offer a limited direct prime brokerage offering to its FX customers.

Andy Coyne

This has given algorithmic traders the opportunity to get as much access to as much liquidity as they require. But he believes this style of trading is not an issue for prime brokers, as, despite the sheer ticket volume, the trades tend to be highly automated. The only potential issue is one of processing capacity and associated costs, which need to fall across the industry. He says: "We have a lot of ideas

Connectivity to liquidity

Citigroup developed its FX Prime Brokerage desk more than six years ago. The desk primarily services hedge funds but Citigroup has other clients such as financial intermediaries and users of other foreign exchange services, as a direct result of the growth in e-commerce and ECN platforms. According to Andrew Coyne, head of FX prime brokerage at Citigroup, although prime brokerage gives users access to liquidity and credit, it is really about connectivity to liquidity as well as trade flows and workflow. Coyne says: "A number of years ago FX

around using technology to improve and differentiate our offering around

FXPB platform in response to clients' demands and suggestions, as well as our own enhancements. This flexibility is entirely due to us retaining full control over our in-house developed systems."

and ECN fees, online reporting tools with real time price feeds, credit utilisations and option volatility surfaces. Highlights within PB are cross-product margining, Financing and Securities Management and our highly automated and flexible FXPB platform. Clients appreciate the real time information available on our FXPB interface such as positions with revaluations, credit utilisations, display of executing brokers."

Traiana's Mandelzis maintains that FX prime brokerage is now a business that is essential to any FX player because of the massive volume and because hedge funds are so important today. "The hedge

funds are taking such a huge market

Morgan Slade

share and their vehicle to participate in the market is prime brokerage. The growth in FX prime brokerage has exceeded the expectations of every participant in the market." Mandelzis

believes there will be continued growth in electronic trading and a focus on lowering costs through further automation. Part of the competition is about getting the costs right but, he says, a bigger issue is growing around capacity. "A number of

Going beyond traditional client base

Morgan Slade, vice president of Penson and director of the Quantitative Execution Group, says: "Increased competition in

According to Allen, going beyond the traditional client base provides a huge array of opportunities for clients to gain access to better credit, better liquidity and reporting functionalities. He says:

hedge funds has really driven people to stray from their typical areas of looking for alpha with more equity traders trading FX. We have access to many of the top liquidity pools for FX trading and have trading relationships with many banks. We do not offer a traditional prime brokerage product yet but hope to add that in the future."

He believes the key differentiators in FX prime brokerage continue to be flexibility, technology and customer service.

prime brokerage changed from being manually driven product to an electronically driven one ­ more efficiencies, more electronic products and ECNs helped drive volume. The most dramatic boost to the prime brokerage market in recent years has been the development of the Traiana automatic give-up systems and the introduction of real-time matching."

"Dresdner Kleinwort's cross-product, cross-margining PB service suits an increasing number of clients who benefit from the collateral efficiency this generates. As the e-FX world continues to capture increasing market share, it will be important to continually develop the scope of automation to liberate more resources for improved client service in areas where human interaction is valued."

banks are starting to be concerned about their capacity as the volumes continue to grow dramatically. A large prime broker was doing hundreds of daily transactions, but in a couple of years that will be tens of thousands a day. That has implications for the downstream systems."

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