FX Prime Brokerage:
Risks and Challenges
Global Operations Managers Conference
Hosted by the FX Joint Standing Committee
April 20-21
Growth of FX Prime Brokerage
Overview:
Foreign exchange prime brokerage (FXPB) came to the forefront in the late 1990’s but had
limited traction.
Over the last 3 to 4 years, the Industry has seen explosive growth in this business fueled
by increased interest in FX as an asset class and the soaring number of new hedge funds.
Entering the FXPB space may be a valuable way for banks to leverage existing
infrastructure and investment.
Primary clients:
Hedge funds
Commodity trading advisors (CTA’s)
Traditional asset managers & regional banks
How it works:
Clients trade with an executing brokers, who then "give-up" their trades to the FXPB for
trade processing.
The FXPB acts as a central counterparty to the clients’ transactions:
Holding any collateral required for trading
Extending credit lines
Becoming the central back office for the client
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FX Prime Brokerage Model
Client Execution + PB instructions
Trades with a number Executing broker
of bank counterparties
Client may out-
source PB confirms
block trade Trade given
operational up to PB
functions with Broker
Prime Broker
Operations
confirms allocations
with Client and/or
middle office
Service Provider provider
Manages the operational
support for the client FX Prime Broker
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Value Proposition
Client
Access to multi-dealer pricing and liquidity
Realize operational efficiencies, STP and reduction in capital expenditures
Collateral requirements aggregated with the FXPB
Trade allocation, confirmation and settlement consolidated with FXPB
Consolidate and customize reporting through the FXPB.
Primary documentation required only with the FXPB
FXPB
Generate new fee-based revenue stream
Develop new and strengthen existing client relationships
Leverage technology and operating infrastructure
Executing Broker
Increase execution flows by transacting business with less credit worthy counterparties by
implementing Give-Up Agreements
Efficient operational flows as the parties to the trade are dealers
However,a complex web of relationships is created which has prompted
review by the Industry
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Risks & Challenges for the Prime Broker
Risk Challenge
Credit Risk Managing exposure to highly leveraged clients (hedge funds)
Establishing appropriate credit terms (VaR vs Initial Margin)
Real time monitoring of liquidity within the terms of the Give-Up Agreement
Lack of standardized Give-Up Agreements
Liquidity FXPB shares credit lines with the Firm’s Franchise Business
Risk
Operational Monitoring of post execution events (exercises, barriers..)
Risk Clients outsourcing operations
Notification of the “give-up” trade is primarily manual (Reuters & e-mail)
Identifying incoming trades as Franchise or FXPB related
Market Risk Managing basis risk introduced by a client putting on option and NDF
positions and taking off these positions with different executing brokers
(pass through / non pass through)
Resolving disputes between the client and executing broker
Reputational Creating a “Chinese wall” to segregate a Firm’s Franchise and FXPB
Risk business (client confidentiality)
Identifying off market trades
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Risks & challenges for the Executing Broker
Risk Challenge
Credit Risk Monitoring credit limits within the parameters of the Give-Up Agreement
Lack of standardization in Give-Up Agreements
Trade rejection by the FXPB
Operational Notification of the “give up” trade to the FXPB is manual (Reuters and e-
Risk mail)
Market Risk Delays in the client notifying the FXPB of a trade exposes the executing
broker to extended market risk.
Reliance on the FXPB to properly match trades and highlight
discrepancies
Trade rejection by the FXPB
Reputational Failure to “give-up” trades in timely fashion
Risk Requirement of the U.S. Patriot Act to Know Your Client (KYC)
Electronic Communication Networks (ECNs) eliminate the ability of the
executing broker to identify the underlying account.
Executing off market trades
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Risks & Challenges for the Client
Risk Challenge
Confidentiality Reliance on PB to implement proper “Chinese walls” segregating the
Risk clients portfolio from the PB’s franchise business
Concentration Clients put “all their eggs in one basket”
Risk If the credit worthiness of the PB deteriorates or the relationship
terminates, the client may be faced with credit, liquidity and/or
operational risks.
Operational Reconciliation of portfolio with FXPB
Risk Trade rejection by the FXPB
Monitoring of post execution events (exercises, barriers..)
Market Risk Failure to notify FXPB of trades in timely fashion
Reliance on the FXPB to properly match trades and highlight
discrepancies
Managing basis risk introduced by putting on and taking off option,
derivative and ndf positions with multiple brokers
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Industry Initiatives
Market participants, central banks and industry organizations have come
together to address some of the broader systemic risks emerging in the
FXPB business.
Current Initiatives:
The FXJSC Prime Brokerage/E-Commerce Sub Group is conducting an analysis of
the development and risks associated with FXPB with the goal of making
recommendations of guidelines to be included in the NIPS Code.
The NY Fed FX Operations Managers Prime Brokerage Sub Group is reviewing the
operational issues and risks associated with the FXPB business
NY Foreign Exchange Committee (FXC) / Financial Markets Legal Group (FMLG):
The FXC published a standard Give-Up Agreement
The FMLG is undertaking a review, in consultation with the U.S. Department of
Treasury, of the KYC responsibilities foreign exchange executing brokers have
under the U.S. Patriot Act
Participating dealers must continue to work together to create automated solutions for
the notification process. Existing vendor solutions provided by Traiana and FXall but
are still in the early stages.
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