Best Prime-of-Prime Provider: ADS Securities

Prime-of-prime (PoP) in foreign exchange has gone from a small, niche corner of institutional trading to the forefront of industry discussions in the space of little over a year. While the spurs for growth are widely understood to be regulatory-driven retrenchment from bank prime brokers, the meaning of the term still inspires heated debate.

"When we went live, I thought we were just closing the gap with other PoPs and the challenge was going to be selling it. The interesting thing I realised is that most of the PoPs are not offering true prime-of-prime; they're offering a principal trading facility, where they get access for certain net open positions. The client pays margin, but the pricing [that] clients see is aggregated anonymously by the prime-of-prime," says Marco Baggioli, chief operating officer of ADS Securities Europe, the winner of the Best Prime-of-Prime Provider category at the 2016 FX Week e-FX Awards.

The interesting thing I realised is that most of the PoPs are not offering true prime-of-prime; they're offering a principal trading facility
Marco Baggioli, ADS Securities Europe

Baggioli's approach to setting up a PoP product was to recreate the model used by a traditional FX prime broker (FXPB), including access to multiple liquidity sources and offering a full suite of products, including credit for non-spot contracts.

The process, however, adds an extra layer of cost for the end-client. But firms strapped for credit are willing to pay to get access, and prime brokers are able to capture a segment of the market they would otherwise have lost due to laborious know-your-customer (KYC) requirements and the changing economics of servicing smaller clients.

"The difficulty is all down to KYC, in terms of what the prime broker doesn't or can't do. For example, the regulations on KYC, and the industry overall, impose that anybody has to do due diligence on every party they know to take part in a transaction. A bank cannot do that for all our clients. The important thing is that I act against my prime broker as a principal and then I have a back-to-back transaction with my client," Baggioli says.

Narrowing the gap

He estimates a typical PoP customer would expect to pay around $10 per million for credit, compared with large bank FXPB clients who only shell out in the region of $3–4 per million. But this gap will narrow.

"In general, I see an increase in direct prime brokerage costs for the small players, so the gap will ultimately narrow. PoP is hovering around $10 per million, but the same person who pays $10 per million for PoP, if they were eligible to go directly with their smaller business to a PB, would be charged around $7," says Baggioli.

"I believe over time, prime brokers will charge even more than $7. Today, it is certainly a shock going from $2 historical PB pricing to $10 per million, but if you were priced today, the same prime broker would charge you significantly more," he concludes.