The number of foreign exchange prime brokers (FXPB), which help clients source FX liquidity from a variety of liquidity providers, has been in steady decline for years. Many banks have pulled out of offering FXPB services due to rising costs and regulatory requirements, while those that remain in the business have adopted an increasingly selective approach as to who they choose to onboard.
The trend is highlighted in the results of the most recent Bank for International Settlements’ Triennial Central Bank Survey. While trading in over-the-counter FX markets saw a 14% increase, to reach $7.5tn per day in April 2022, prime-brokered turnover decreased by 13%, from $1.5tn in April 2019 to $1.3tn in April 2022.
Many hedge funds — especially smaller ones — are feeling the brunt, as some providers will only extend an FXPB line if the client will purchase other services, such as execution. This has led to a consolidation in the number of relationships and an increase in concentration risk, with many hedge funds voicing concern about being dependent on an ever-smaller pool of providers.
In a recent survey among 57 hedge funds by market intelligence firm Acuiti and Standard Chartered, the vast majority reported having multiple FXPB relationships. However, those that had one FXPB tended to be hedge funds with smaller assets under management (AUM) or report low FX volumes as the reason for a single relationship.
And while 40% of respondents report being able to maintain the same number of FXPB relationships over the past three years, 39% recorded a reduction in number.
Of the firms that had fewer FXPB relationships, 38% had done so based on an internal decision to consolidate relationships, while 24% had cut the number they work with because they had been offboarded by their existing provider. Offboarding was a particular issue for hedge funds with lower AUMs — just 18% of firms with an AUM of more than $1bn had been offboarded, compared with around a third of those with an AUM of below $1bn.
Offboarding can be disruptive and negatively impact the business. Firms that had lost access to an FXPB reported reduced access to liquidity, costs of reallocating and integrating with a new provider, and increased operational risk. Yet, 38% said that they did not have an executable backup plan if they were offboarded by their core FXPB provider.
In addition, a third of respondents that had reduced FXPB relationships reported that one or more of their providers had withdrawn from the market. This is an area of growing apprehension: almost seven out of 10 respondents were either very or quite concerned about the impact that the withdrawal from market of one or more of their FXPB providers would have on their business.
Setting up new relationships is also fraught with issues. When asked what the biggest challenge is when onboarding a new FXPB relationship, survey respondents cited: finding the right provider, getting accepted by the preferred provider, internal opposition to change, lack of operational time/resource, and lack of legal time/resources.
Clearly, hedge funds — particularly new launches and those with smaller AUM — face a challenging landscape when managing FXPB relationships. Yet, many need to have greater access to emerging and frontier markets — 61% of respondents said that the ability to add any global currency to their tradable universe would enhance their trading strategies. Funds are on the lookout to find FXPBs both willing to onboard them and to offer the diversity they need.
Joy Macknight is editor of The Banker. Follow her on X (formerly known as Twitter) @joymacknight
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