FX Prime Brokerage Model FX Prime Brokerage Risks

Document Sample
FX Prime Brokerage Model FX Prime Brokerage Risks Powered By Docstoc
					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
   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
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
                                 confirms allocations
                                  with Client and/or
                                    middle office
      Service Provider                 provider
       Manages the operational
        support for the client                                     FX Prime Broker

 Value Proposition
     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

     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
 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
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
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
                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

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
                 Managing basis risk introduced by putting on and taking off option,
                  derivative and ndf positions with multiple brokers

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.


Shared By: