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NBLP vs PoP

NBLP vs PoP

The term Prime of Prime has become omnipresent in the leveraged trading industry, and by many accounts the intention of what it was supposed to stand for has become somewhat diluted over the last five years or so. With news that one of the last big broker-dealers operational in APAC is looking to direct its liquidity offering to a more mainstream audience, and as a result is stepping back from providing brokers and smaller banks with market access, many participants will be left asking what they should be doing next. Do they look to source a new prime brokerage relationship, maybe with a non-bank liquidity provider (NBLP), or do they simply default to a Prime of Prime (PoP) relationship? So, at a time when liquidity offerings across currency markets is rising sharply, it’s worth being aware of the options on the table - and understanding their respective costs and benefits.

Is Prime of Prime robust?

Whilst the Prime of Prime movement arose off the back of legacy liquidity providers increasing minimum order flow sizes and becoming that much more selective as to who they would take on as a counterparty, the first wave of participants, namely a number of the very well capitalised brokers, found themselves quickly pushed to one side by liquidity recyclers who were competing on cost but who also had no scope to do anything more than aggregate and mark up the flow which was already in circulation. As a result, the idea that these Prime of Prime innovators could act as a condiut to accessing tier one liquidity failed to hold. And whilst in calmer markets with significant depth this issue could be largely brushed over, when more volatile conditions prevail and order sizes increase, the shortcomings were laid bare.

Critically, the lack of transparency between counterparties in the Prime of Prime space means that those looking here for liquidity can be vulnerable to finding orders contested, as multiple PoPs can be trying to access the same pool of liquidity.

Problems just starting to build

For well over a decade, ultra lax monetary policy has been dominating the economic agenda and as a result, volatility on the majority of currency pairs has been significantly subdued. Those who have been seeking exposure have had little problem in ensuring they can tap into the market at the necessary scale and see orders filled promptly. However now that central banks are starting to turn the screw in terms of hiking rates as they bid to dial down inflationary pressures, the market is seeing some fundamental change. And whilst the Hungarian Central Bank may have surprised the market with a 200 basis point hike, it’s not just the outliers where the surprises are coming from. The Swiss National Bank stunned many when they elected to deploy a 50 basis point hike in June 2022, driving price action on the usually erstwhile USD/CHF pair to significantly elevated levels. With inflationary pressures showing no signs of abating and recession threats looming, there’s little reason to believe that the central bank intervention – and accompanying wild swings in currency prices – will dry up any time soon.

So what’s better than Prime of Prime?

Smaller counterparties are indeed constrained by the limited number of direct liquidity providers open to trade, but this sector is one which has innovation and evolution very much at its heart. As a result, a small but growing number of the more established FinTechs are harnessing their own networks, technology, internal flow and balance sheets to present a more comprehensive offering here. CMC Markets, via its institutional CMC Connect division, is one such example. With proprietary technology supported by a team of in-house developers, the company is using its own balance sheet to leverage relationships with Tier One liquidity providers. On top of this, because CMC is ingesting prices from so many different sources and also has a significant pool of retail client flow at its disposal, the company can quote consistent prices at depth which has the potential to exceed what others can see in the underlying market. And because there’s no absolute reliance on the CMC to take liquidity from another institution before completing on a trade, the company is now positioning itself as a Non Bank Liquidity Provider (NBLP).

As Andrew Wood, head of Institutional at CMC Markets Connect, commented: “The beauty of our structure is if institutional clients do get another Prime Broker then we can offer our non bank liquidity via give up. Conversely, if they go for a prime of prime then they can also look at using our liquidity directly to give them a truly unique liquidity proposition, rather than for example using two Prime of Primes who are likely offering the same recycled liquidity.”

Will Prime of Primes disappear?

This seems unlikely, as they still play a role in feeding liquidity to smaller brokerages and because they are simply aggregating rather than assuming any meaningful risk, costs are likely to be lower. However it’s worth bearing in mind that given the constraints they operate in, unfilled orders and requotes are far more likely, especially in faster moving markets. And the industry will without doubt continue to evolve. The NBLP model we see today is certainly robust and arguably fills the role which had historically been performed by Tier One liquidity providers, yet at a lower cost. But most critical is the fact that counterparties looking to review or initiate liquidity relationships have a true understanding of what they are getting. Headline prices shouldn’t be the only metric considered as over the longer term, the outcome is unlikely to be the mist beneficial.