Could prime of primes go pop?

Prime brokerage has had its share of bad headlines in recent years, but at least one corner of the industry is booming: so-called prime of primes (PoPs) catering to foreign exchange traders. 

PoPs act as credit intermediaries in currency markets, connecting clients such as retail brokers and smaller hedge funds to tier one liquidity providers. Some claim to be experiencing double-digit growth, both in trade volume and client numbers. Saxo Bank, one of the largest providers of PoP services, said in a recent investor relations report that its total client base has grown more than 230% since 2018.

This presents something of a conundrum for the largest banks. Many of them cut ties with scores of less creditworthy clients after the 2015 Swiss franc de-pegging inflicted substantial losses on retail brokers and hedge funds. Another round of client-cutting followed when the 2018 collapse of the GTEC Pandion hedge fund left Citi with a $180 million loss. Now, many of these same clients are finding their way back into the fold via PoPs.  

Within large banks, opinions about PoPs are mixed. Some say they play a useful role in diffusing risk. Because PoPs consolidate the flows of lots of small clients that often have offsetting positions, their business tends to be more balanced and diversified than many of the larger customers that tier one banks deal with directly. 

Others say that banks should not be taking indirect exposure to end-clients they wouldn’t do business with directly. 

For now, plenty of banks are eager to do business with PoPs. But it is understood that at least two of the world’s largest FX prime brokers have decided to steer clear of them, at least for the time being. A blow-up could send many more running for the hills.  

As more providers enter the market, some see a potential shaking out of PoPs into their own tiers

PoPs are well aware of the need to maintain the confidence of large banks. The top firms are investing heavily in customer due diligence and risk management systems. But as more and more brokers get into the business, competition is intensifying, with some PoPs offering greater amounts of leverage to attract customers. 

As more providers enter the market, some see a potential shaking out of PoPs into their own tiers, with smaller players primed by the larger PoPs that have direct relationships with tier one banks. That could make it even more difficult for large banks to monitor and manage the risks posed by this client base.  

There is little doubt that PoPs are playing an important role in the market in filling the void left by retrenching banks. Many are highly reputable, with strong risk management and first-class systems. They provide a crucial service to smaller firms and are more attuned to the needs of these clients. 

Their emergence could make the FX market safer and more robust. But after years spent de-risking their FX prime brokerage operations, some banks are clearly worried that if things went wrong, this new breed of clientele could put them right back where they started.