Listen to the Article: Prime Brokerage, Its Trends, and Ways to Innovate

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Fazzaco has previously discussed in the article "Invast Is Now 26 Degrees, and This Is Why They Renamed Themselves" how the banking crisis led by Silicon Valley Bank and Credit Suisse in the United States sparked a "mass exodus" of many institutions from the prime brokerage business starting from 2023.

In fact, in the past decade, the prime brokerage business has often seen a vicious cycle of service providers cutting back their services. Today, let's take a look at what's driving the ups and downs in the prime brokerage market, as well as the current trends and technological innovations.

Prime Brokers Are the Bridge Connecting Tier-1 Liquidity

It goes without saying that liquidity is crucial in the forex community. The higher the liquidity, the lower the cost of instant trading. In other words, high liquidity translates to low transaction costs. The better the quality of liquidity, the smoother the broker's transactions, and the greater the competitive edge. Therefore, high liquidity is a boon for forex brokers.

Multinational banks such as Citibank, Deutsche Bank, JPMorgan Chase, HSBC and so on are obviously the first-tier liquidity providers, but at the same time, tapping into their top-tier liquidity also requires hefty costs and technical requirements, which are only suitable for deep-pocketed brokers and funds. So, services directly provided by these big banks are called prime brokerage (PB), and more small and medium-sized forex brokers use PoP services, which we will talk about when we discuss PB market trends.

PB: Services Reduced, Providers Exited, Technologies Outdated

Over the years, changes in prime brokerage have taken a toll on the cost and quality of the services provided, causing many brokers and funds to run into a liquidity crunch. Many institutional clients have been forced to make some decisions that may not suit their portfolios, workflows, cost structures, operational and competitive strategies.

Objectively speaking, changes in PB services can be attributed to the side effects of major participants bowing out of this field. In terms of prime brokerage services and their corresponding regulatory and reporting requirements, they are inherently volatile; we can even trace back to the 2015 Swiss franc black swan event that rocked the entire forex market. As a milestone event, the number of banks willing to provide PB services to brokers nosedived sharply. Although some hedge funds can replace banks as liquidity providers, they are subject to regulatory restrictions and cannot become PB service providers.

Subjectively speaking, prime brokerage providers invest very little in risk management, including artificial intelligence, a technology that has been all the rage recently. Most institutions still use legacy techs, resulting in isolation between systems and interfaces, unable to get the agility and efficiency that they should have, and this trend may continue. Taking the US securities industry with a market cap of more than 900 billion US dollars as an example, this industry still relies heavily on mainframe technology born in the 1980s.

This is like building a new house on an old foundation. The foundation will collapse sooner or later, and the entire structure will follow suit.

The Rise of PoP & Ways for PB to Innovate Itself

We can see that PB services have been on the decline over the years, while another PoP (Prime of Prime) model is on the rise. Many brokers, clearing institutions and exchanges that have PB partnership with banks have started to provide liquidity solutions for small and medium-sized brokers, becoming secondary brokers, which are also LPs that we see more frequently in the forex market in recent years. This includes B2Broker​ and CMC Markets, both of which are Fazzaco's partners.

On the technological level, the fact that PB providers are technologically backward is the reason to their low efficiency and reduced profit margins but increased risks. Therefore, they should focus on techs that reduce manual intervention and adopt automated and cloud-based solutions.

Finally, the rise of AI craze, most prominently the ChatGPT, also represents a new genre of innovation. Although currently the development of AI in finance is far faster than regulation, AI's universality suggests huge potentiality for development in prime brokerage services.