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					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
                                                                                                   4
 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
                                                                                                5
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

                                                                                         6
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


                                                                                        7
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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