Beware of Revenue Share Deals with Liquidity Providers

ESMA Chairman targets asset managers for adequacy of liquidity concerns

Jeff Wilkins, Managing Director of IS Risk Analytics highlights the pitfalls for brokers of revenue share opportunities with Liquidity Providers, in a special guest post exclusive to LeapRate.


Jeff Wilkins IS Risk Management

Jeff Wilkins, IS Risk Analytics

As with any deal, if it seems too good to be true, it normally is. With many Liquidity Providers now offering revenue shares we are increasingly seeing that once you scratch the surface, these arrangements are not what they seem. It is important to investigate the details rather than being blinded by headline figures as there are many tricks that are deployed to make a revenue share  offer look better than it is.

We believe that the best relationships are collaborative, where LPs take risk alongside a client, providing a transparent service rather than purely a black box designed to enrich only one side of the equation. To this end, the following are aspects that you should consider when questioning your provider as to what they are actually offering.

There are many tricks to reduce the true P&L of the book before paying the revenue share out. Think about your commercials very carefully. Even a 100% revenue share isn’t all that appealing, if it is only paid on 10% of the true book revenue.

1. Legal Documentation

  • Look very carefully at the legal contract that is being offered. Are there clever ways for the provider to avoid paying? What has the provider actually committed to deliver?
  • Do the legal documents give the provider the opportunity to retrospectively cancel trades, claiming that they don’t meet the flow profile that was agreed to? Are you giving your provider a free option?

2. Transparency

  • Shared book or separate book? Is the provider running a separate book for your revenue share, or are they simply running a global book across all of their risk, and splitting out P&L in an un-transparent manner that is skewed in their favour? If your book has a particularly good quarter, are the hedge costs mysteriously higher than in the previous quarter, but on similar volume?
  • “Hedging costs” – Is the provider only allocating hedging costs to their own benefit? Is hedge P&L always negative, or is it ever positive? Hedging costs are a very effective way for the provider to artificially reduce the P&L on the book.
  • Regularity of reporting – Is the provider reporting P&L daily, weekly, monthly or quarterly? Most providers report on a quarterly basis, which makes it easier for them to be less transparent about the true P&L of your book.

3. Spreads

  • Is the provider offering competitive spreads? Often revenue shares are offered on uncompetitive spreads, which means that you are simply subsidising risk revenue by paying additional spread revenue to the provider. Does the quality of spreads deteriorate if your clients are having a profitable month?

4. Execution

  • Are you receiving a high quality of execution from your revenue share partner? Does this deteriorate if your clients are having a profitable month?

5. Does the broker have sufficient risk capacity allocated to your book?

  • Many of the larger retail brokers offer revenue shares to other brokers. Given that large retail brokers already have large risk books, are they allocating the necessary risk capital to you? If their risk increases on their own internal book, they will naturally allocate capacity away from your risk book
  • For institutional brokers, does the provider have sufficient risk capacity to run the amount of risk that your book requires? Are they transparent about the limits they are allocating to you?

6. Is the provider a competitor?

  • Revenue share relationships have to be built on trust.  Is the provider a retail broker too? Do they genuinely have your best interests at heart? Do they have related retail brands? Do they claim not to take on retail, but take on IB’s who introduce retail business? Why are you providing flow and revenue to a competitor?

7. Is there any value add in the offering?

  • Is the provider simply providing an MT4 cover account? If so, are they simply blindly B booking all of your flow or are they selecting the right flow to internalise, and the right flow to STP?
  • Does the provider have the capability to allow you to move certain clients to STP, isolating them from the revenue share? Or do they simply instruct you to remove clients completely? How much flow and revenue have you lost from switching off clients?

8. Is the commercial offering “too good to be true”?

  • Does the commercial offering mean that the provider can only hedge at a loss? If this is the case, then they are probably simply hoping that the flow will be loss making and will be likely to cancel profitable trades.
  • Is the provider running the revenue share themselves or are they re-selling something that they have from another provider? This is rarely sustainable, and also means that you are not getting the best commercial offer available in the market.

If you run a retail brokerage and are using a revenue share provider, we strongly encourage you to look diligently into the above questions. We come across providers of all shapes and sizes and the revenue share counterparties generally are the slipperiest actors in our industry. Looking externally, we have yet to see a provider perfect this model and the imperfections that do exist are always to the detriment of the retail broker. As with all vendors and providers, do your homework before you commit.

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