With the evolution of foreign-exchange trading, prime brokers that extend credit to hedge funds and commodity-trading advisers (CTAs) are coping with multiple execution venues and manual processes in a business that can be extremely risky.
Today, a typical FX deal works like this: A buy-side customer enters a trade into the Reuters Dealing system, directly into a multi-bank FX portal, or into a single-bank portal. The FX portal will notify the prime broker that a trade has taken place, and the prime broker notifies the customer. The executing bank will also "give up" trade details to the prime broker by sending a fax or e-mail, or typing a text message into a Reuters conversational-dealing system. Finally, the prime broker has to manually re-key that information into its systems and try to match both sides of the transaction.
Today, buy-side customers of prime brokers opt to trade with voice brokers over the phone or use the Reuters Dealing 3000 system, but increasingly they are going to multi-bank FX trading portals like FXall, Currenex, FX Connect and Hotspot FXi, as well as single-bank portals.
"We've got very diverse places where trades can come from, not to mention our own portal, where we get (give-up) trades from all different kinds of formats and all different kinds of methodologies. It's very much a web of businesses," says Joseph Buthorn, senior vice president, prime brokerage, AIG Trading Group Inc.
This poses a challenge for prime brokers, which provide many post-trade capabilities for their buy-side customers, including trade matching, reconciliation, allocations, billing, reporting and clearance and settlement.
Recently, two technology initiatives have emerged - one led by a trio of prime brokers and a software vendor, and the other from FXall, an online multi-bank FX-trading portal - to help prime brokers streamline their operations by making the process more electronic.
On April 7, three major FX brokers (AIG Trading Group Inc., Deutsche Bank and JPMorgan Chase) joined forces to create a central online-communications hub called Harmony, where executing brokers will report give-up trades to the firms on behalf of buy-side customers. Give-up trades are necessary because the hedge funds and CTAs are trading in the prime broker's name, and so the client's name has to be given up to the prime broker for clearance and settlement purposes.
The banks are working with Traiana Inc., a software developer based in San Mateo, Calif., specializing in prime-brokerage systems.
All three banks utilize the Traiana Arch system to connect with their buy-side customers. Forty hedge funds have been integrated into the prime broker's Traiana Arch system. "Harmony plugs in like a pipe into Arch's matching engine," says Buthorn, who explains that AIG uses Arch to match customer trades against trade reports coming in from the executing brokers.
"It's a significant differentiator in terms of the way that we provide service to the entire prime-brokerage market - clients and executing brokers alike. And that's a big deal," says Buthorn.
Meanwhile, on April 14 - one week after the three prime brokers and Traiana announced Harmony - FXall announced plans to launch a solution for prime brokerage, allowing real-time messaging through Trading Center and automatic notification of prime-brokerage deals between banks through FXall's Settlement Center.
A spokesman for FXall says, "The banks have yearned for a real-time messaging system that will alert them when their clients have done a trade with a prime broker or a bank, so they can enter the deal into their prime-brokerage system or directly into their risk-management systems."
Since a prime broker deals with anywhere from 45 to 60 executing brokers, "A lot of the responsibility goes to the prime brokers to make these connections," says Sang Lee, manager, Securities and Investments Practice, Celent Communications. "All the data points have to be re-keyed, increasing chances for errors which certainly does not help any of the market participants," says Lee.
Traiana aims to eliminate this extra step by using tools with eXtensible Markup Language (XML) to grab the data electronically in any format directly from the executing banks' dealing systems. "By making this fully electronic, you're really just asking each firm to link into this one utility."
TWO MANY COOKS?
Both Harmony and FXall's messaging service are supposed to go live in the third quarter. The question is whether the two industry efforts are competitive and which one will build critical mass first?
"The portals could potentially be a nice tie in to this overall structure," comments Lee, who believes the efforts are not competitive because, "The prime brokers are not really focusing on the execution service," he says. "Most of those portals are providing liquidity into the marketplace, whereas this utility (Harmony) is not," he says. "If anything, by tying all these portals into this utility, you're trying to create more streamlined back-office operations, as opposed to competing with what the portals are trying to do."
Gil Mandelzis, Traiana's chief executive officer, says, "To us, this is a very complementary service," adding that his firm has spent three years coding the solution. "The prime brokers do not want to impose upon a client one venue of trading (such as) Hotspot or FXall or FX Connect," for example. "They want to tell their clients, 'You get the best price wherever you can get it, but clear the trade through me,'" he says.
Traiana plans to form partnerships with most of the FX-execution platforms throughout this year, says Mandelzis.
AIG's Buthorn says that Harmony can be a central integration point into all the online FX-trading portals. "AIG Trading will use Harmony and Traiana, in general, to standardize all the incoming trading feeds from all the different portals that are springing up. My problem is that I've got customers that want to trade everywhere and anywhere they can. They want to do business in the voice market, they want to do business on Hotspot, FXall, on AIG's platform and on Barclay's platform," he says, referring to single-bank portals which offer trading and analytics. "What Traiana does for me and what Harmony does for me (is) it allows me to put their platform in front of AIG to be the integration mechanism for all those different entry points."
In terms of connectivity and reaching critical mass, FXall plans to leverage an existing network infrastructure that links 43 liquidity providers - composed of banks, prime brokers and custodians - to 450 institutions, says FXall's spokesman. Because the prime-brokerage offering is being built into Settlement Center, a standalone product, he adds, "As a member of Swift, we can send prime-broker messages over the Swift network," suggesting it can reach prime brokers or banks that are not participating in FXall.
Mandelzis maintains that by pulling in Deutsche Bank, AIG and JPMorgan, "We have created an incredible critical mass in terms of the prime brokers themselves," and he says that additional prime brokers are going to be added this year.
One industry source maintains that FXall's connectivity is mainly to front-office dealing systems. "For post-trade, it's irrelevant. They're not connected to the (middle- and back-office) operations of the prime brokers."
The same industry source says that FXall does not have comparable functionality to Traiana, in terms of being able to allocate block trades to sub-accounts at the (hedge) fund level. "This is a function that is completely operational internally to the prime broker and this is a capability that executing platforms do not have today," the source contends.
The FXall spokesman refutes this notion. "One of the products we offer is the ability to split transactions on a pre-or post-trade basis. If a client needs to book allocations after the prime-brokerage deal is done, we have the ability to book transactions into their risk-management systems. In fact, we already have prime-brokerage customers that we help out doing that through their bank or custodial bank," he says. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio