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FX prime brokerage: fuelling the next round of growth

Posted: 10 November 2010 | FX-MM | No comments yet

Now that the dust has settled, FX-MM’s FX Prime Brokerage Supplement outlines the key trends taking place in this fast growing sector. By Frances Maguire

Prior to the global financial crisis, FX prime brokerage was experiencing rapid growth as real money and asset managers joined the growing ranks of hedge funds turning to prime brokers to get the best deals in FX through a single platform as well as gaining access to services developed specifically for them. In addition, there were a growing number of algorithmic players moving across to FX from the equities and futures world that are starting to participate in trading FX as an asset class.

Now that the dust has settled, FX-MM’s FX Prime Brokerage Supplement outlines the key trends taking place in this fast growing sector. By Frances MaguirePrior to the global financial crisis, FX prime brokerage was experiencing rapid growth as real money and asset managers joined the growing ranks of hedge funds turning to prime brokers to get the best deals in FX through a single platform as well as gaining access to services developed specifically for them. In addition, there were a growing number of algorithmic players moving across to FX from the equities and futures world that are starting to participate in trading FX as an asset class.

Now that the dust has settled, FX-MM’s FX Prime Brokerage Supplement outlines the key trends taking place in this fast growing sector. By Frances Maguire

Prior to the global financial crisis, FX prime brokerage was experiencing rapid growth as real money and asset managers joined the growing ranks of hedge funds turning to prime brokers to get the best deals in FX through a single platform as well as gaining access to services developed specifically for them. In addition, there were a growing number of algorithmic players moving across to FX from the equities and futures world that are starting to participate in trading FX as an asset class.

The credit crisis had a profound effect on the FX prime brokerage market. The collapse of Lehman Brothers and the government bailout of American International Group (AIG) in September 2008 greatly impacted the hedge funds and other prime brokers and the industry has since undergone far-reaching structural change.

The collapse of Lehman Brothers made prime brokerage clients seriously rethink their counterparty credit risk exposure and as a result the shift towards the multi-prime model – in a bid to diversify credit risk – has been revisited. Meanwhile, organisations that could not demonstrate real time risk monitoring had to dramatically downsize, with new participants, with stronger balance sheets, replacing those that have exited or scaled back their business.

One such new entrant is BNP Paribas, which launched into the FX prime brokerage market earlier this year, with its prime brokerage platform, Infinity, following the acquisition of the prime brokerage platform and team from AIG.

The credit crisis not only gave rise to new models in FX prime brokerage but in many ways has meant that the FX prime brokerage product is still evolving. This reshaping of the FX prime brokerage market, as both prime brokers and customers reassess their exposure to counterparty credit risk, has led to much greater emphasis on margining and limit monitoring in real time, as the market places greater focus around the management of risk and collateral. And, not surprisingly, the need to diversify counterparty risk by appointing more than one prime broker has made the FX prime brokerage even more competitive, with the largest FX prime brokers leading the way in the service levels and product range being offered.

FX prime brokerage grew out of the demand for more efficient use of collateral and increased credit lines by concentrating assets and clearing centrally with a prime broker. As foreign exchange continues to develop as an asset class and as investors in global markets who use currency overlay programs look to protect themselves from volatile exchange rates, the demand for FX prime brokerage is increasing once again, but the focus on risk management has opened up a whole raft of new opportunities. This is leading to the provision of cross-product capabilities.

There are a number of market dynamics that are shaping the priorities of FX prime brokerage clients but the one that will determine the future prime brokerage model is the final outcome of incoming regulation – namely the inclusion of standardised FX bi-laterally OTC products for clearing by a central counterparty (CCP) in regulation coming out of both the US Senate and the European Commission. But while the use of a CCP will reduce the need for clients to diversify counterparty risk across multiple prime brokers, many believe it will simply increase the demand for cross-product clearing packages from their prime broker.

Like several FX prime brokers, RBS Prime Brokerage has spent the last year working with other areas of the bank including futures, OTC clearing, collateral trading, financing and e-commerce to bring together RBS Prime Services model which covers all asset classes, and is aimed at providing one clearing solution across OTC, CCP (central clearing counterparty) and exchange clearing venues.

Similarly, the BNP Paribas FX prime brokerage offering continues to be extended, to include capabilities such as real time credit monitoring, multi-currency cash settlement and collateral management, and to ensure that BNP Paribas offers a full multicurrency prime brokerage offering to a broader set of users, including real money managers and banks.

Both banks believe the role of prime broker will continue and evolve, providing access to multiple execution and clearing venues as more products move to centrally cleared platforms, and with prime brokers differentiating themselves in integrating prime brokerage services with these venues. The technology arms race in prime brokerage it seems will continue and spill over into FX prime brokerage.

According to Citi, this will be in terms of clearing products for FX, as the model for both FX and FX prime brokerage goes through much change, and will, Citi believes, lead to a model where prime brokers will offer a mix of cleared and non-cleared FX products to customers. While it is likely that vanilla options and, most likely, non -deliverable forwards will be cleared, spot and short term forwards will not. For Citi, the prime broker’s objective in the future will be to steer clients through these changes, consolidate trading across multiple infrastructures to provide optimal collateral efficiency across their portfolios. More importantly, Citi believes there is a key role for prime brokers to be played in enabling effective margin offsets across portfolios to help soften the blow of having to pay additional collateral to the clearing house.

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