Forex software firms – becoming Prime Brokers???

Two leading technology firms which provide software to the Forex industry – Boston Technologies and Leverate – both recently announced that they had gone through the regulatory process in Europe (BT in the UK, Leverate in Cyprus) to set up regulated Prime Brokers.

Some obvious questions arise:

  • What in the world are two software firms doing becoming regulated brokers?
  • Will BT and Leverate now be taking trading customers and thereby be potentially competing with their own traditional clients, the Forex brokerage firms?

First, a quick word on Prime Brokers. Traditionally, Prime Brokers have been large banks, which allow institutional clients to open an account and trade, via the Prime Broker, with a variety of other trading partners. The client thereby needs to only open one account – with the Prime Broker – instead of many accounts with the many trading partners via which it wishes to trade. But convenience is only part of the picture. The Prime Broker provides a variety of services to the client, such as clearing and securities lending (for shorting purposes) and allowing the client to manage, hedge and consolidate positions across several accounts in one place. However the key part of the relationship usually hinges on one key factor, well known within the Forex world – leverage. The client needs to post margin (if any) only with the Prime Broker, thereby renting the Prime Broker’s larger balance sheet, as its various trading accounts are opened with the different trading firms in the name of the Prime Broker. Some Prime Brokers require little if any margin from their clients, settling any combined losses or gains with the client on a daily (or more frequent) basis. The Prime Broker (traditionally) makes money by charging a per-trade or per-volume fee to its clients, as the client makes trades via the Prime Broker with the various trading partners.

It seems as though BT and Leverate are both leveraging (no pun intended!) their software platforms to become Prime Brokers themselves, connecting their clients to a variety of FX liquidity sources (ECNs, banks, etc.), without the clients having to open accounts directly with each of those sources. (BT’s Boston Prime reports connections to nine liquidity sources, Leverate’s PIM Prime Investments to twelve sources).

The target clients for BT and Leverate here? We would divide them into two groups:

  1. Mid size market-maker Forex brokerage firms, looking for a one-stop-shop solution to hedge their own positions or add an STP-execution-solution for certain traders. These FX firms can thereby avoid the need to open many accounts at banks and ECNs, and avoid the need to post their own margin at each.
  2. Mid to small size institutional traders, who are too small to be accepted as clients at “traditional” large bank Prime Brokers, or who just want more aggressive terms (smaller volume minimums, or lower margin requirements) than the traditional bank Prime Brokers will provide.

It certainly is possible that BT and Leverate will be competing with their own FX brokerage clients here, by taking on high-net-worth-retail and small institutional clients who might otherwise directly open accounts with an FX broker. We have actually seen of late an increase in institutional clients at retail FX firms, such as FXCM reporting more than $100 million of monthly volume with institutional traders in 2011, or about a quarter of their overall volume. Perhaps for this reason both BT and Leverate are using different names than their own for their Prime Brokerage businesses, to somewhat distance themselves and their software brands from the Prime Brokerage.

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