Any broker who is serious about delivering a high-quality trading experience for customers has to be prioritising liquidity. But in a world where the number of brokerages continues to grow, whilst direct access to Prime Broker accounts becomes ever more difficult, how are the trailblazing startups who aspire to be the market leaders of tomorrow supposed to find a break?
In short, in today’s world the reality is that unless you’re one of the very largest retail brokers, you’re simply not going to get direct access to those prized Tier One liquidity pools. The underlying market has been changing for more than a decade, with the number of genuine Prime Brokers contracting, whilst those who remain in the market have ever more stringent demands when it comes to who they are willing to trade with. Counterparties can now expect to go through the most rigorous due diligence requirements, alongside binding demands that significant volumes will be taken, too. This has been driven by changes not only in terms of the risk profiles the legacy players are looking for, but also the internal realisation that this is a cumbersome process and better returns on investment can be achieved elsewhere.
It's not impossible
So, does this make it impossible for those brokers who aren’t willing to risk running big B-books to have any chance of growing a business of their own? That’s certainly not the opinion of Richard Elston at CMC Markets Institutional, who explained “using a liquidity provider such as ourselves can provide access to a wide range of assets at a universally competitive price. What’s more, in addition to leveraging our tier one liquidity relationships and balance sheet, we also have the ability to blend our own retail order book with that of the underlying market, producing a compelling proposition for many banks, brokers and funds.” Such internalisation has already been seen across the major global banks so the approach is far from unusual but put another way, those non-bank liquidity providers who can not only act as consolidators for Prime Brokers but also augment this with ‘free’ internal flow have the potential to deliver in terms of both market depth and price. Furthermore, this comes without those burdensome – or perhaps to put it more bluntly – unachievable trade minimums that the majority of institutions will never come close to. As Elston is keen to add, “it’s often forgotten that entities such as ourselves are now originators of liquidity across asset classes. We can access those tier one feeds for price construction and reference, with the added ability to execute against our own order book to ensure we deliver the best proposition to our customers and all without any risk of market impact”.
Selection of the intermediary
Careful selection of the intermediary has arguably never been more important, either. It’s critical to understand which primary liquidity sources are being used and this is something that becomes especially important in times of fast-moving markets. Recent years have seen significant growth in the so-called Prime-of-Prime brokerages but these come with a real risk that available market depth can end up looking constrained. As CMC Markets’ Elston, notes “it’s important to remember that liquidity provision is a capital intensive function of the market and there’s no such thing as a free lunch. Anyone offering what looks like a cheap deal here may well be recycling liquidity from other smaller brokers, which serves to limit market depth and can ultimately make it very difficult to get orders of any size filled even in normal market conditions”. So whilst that might be an acceptable solution for some, it’s unlikely to lead to a happy trading experience for the client. With this in mind, brokers are likely to find themselves under increased levels of scrutiny when it comes to disclosing who their trades are passed to. And even if this isn’t forthcoming, maintaining competitive pricing and fill rates in the longer term is likely to be challenging without those high quality direct liquidity relationships.
Client demands are also in a state of flux, again a point which CMC’s Elston was keen to stress, adding “the retail end of the market especially has seen something of a renaissance during the COVID-19 lockdowns. Not only did volatility return, but day-traders had the benefit of time to re-engage. Volatility may be ebbing away and people are returning to work, but brokers will be keen to keep this new cohort engaged. Underlying changes in technology such as MT5’s ability to offer a far greater choice of tradable instruments again means that brokers have to ensure the liquidity they are tapping into can cater to the wide-ranging client demand, whilst simultaneously being served up in such a way that it integrates seamlessly with the relevant platforms.”
One interesting upgrade over MT4 is the ability for MT5 to display market depth alongside the price - although this is conditional on the liquidity provider being able to serve data in the necessary format. It might not be a deal breaker yet, but expect more MT5 users to be pushing brokers to providing this functionality in the future, too. As Elston adds, “this is yet another consideration brokers need to be taking into account but liquidity providers like ourselves who invest heavily in their own platforms are already able to deliver this level of detail.”
Classic tier one liquidity may still be revered as the panacea for brokers looking to deliver a better service. However, by digging a little deeper, there’s no shortage of evidence to suggest that the innovators, the fintechs and the new genre of non-bank liquidity providers are themselves already filling a significant role when it comes to improving market access and in turn enhancing the trading experience.