PBs get new help in war on generosity

Big FX venue operators offer way to reduce overallocation of credit

  • EBS and Refinitiv plan to launch credit APIs to help limit PB overallocation.
  • The move will allow for a quicker adjustment of available credit as clients execute across multiple ECNs.
  • This in turn should remove some of the fragmentation of credit across the OTC FX market.
  • The APIs do not fully resolve the industry’s woes, but could be the foundation for future solutions.

EBS and Refinitiv are launching application programming interfaces (APIs) that allow foreign exchange prime brokers (PBs) to automatically adjust client credit limits based on consumption during the day – the latest attempt to tackle the industry’s long-standing problem of overly generous credit lines, and the risks that go with them.

Currently, prime brokers split up each client’s credit line and spread it across the spot FX market’s galaxy of venues – allowing some excess capacity at each of them, so clients can trade without constraint. The venue limits are checked prior to each trade, but a client that executes large trades – or lots of tickets – across multiple venues could rack up aggregate losses far in excess of the client-level limit.

Or, to put it more playfully, it’s like leaving 10 bags of sweets around the house, and telling your kids they can dip into any of the bags, but are only allowed to consume the equivalent of two bags in total. And adding that you’ll be checking at the end of the day to make sure they toe the line. The danger – as any parent will know – is that they eat all the sweets, are seized by a sugar frenzy and burn the house down.

The new APIs will plug into third-party FXPB risk and credit management systems, such as those run by Cobalt and Traiana. Brokers will then be able to review credit usage and update limits across the venues dynamically – in theory, allowing them to reduce the amount of excess credit they offer at each venue.

“This just provides a much more automated and efficient way for them to interface with the credit files on their clients’ behalf, and manage those more efficiently,” says Jeff Ward, global head of EBS.

Refinitiv performed what it calls a soft launch of its credit API at the beginning of July, and is working with Traiana and Cobalt to conduct further testing and integrate the systems with each firm’s post-trade service offerings. A wider launch will see the API made available initially on the Matching platform, but the intent is to have a single API shared across all its FX venues as the London Stock Exchange Group – Refinitiv’s owner – continues to invest in replatforming the venues. EBS’s credit API will be available when the EBS Markets integration with CME’s Globex is completed – planned for later this year – and will manage a single limit across its Markets and Direct platforms.

In both cases, the key benefit is the ability to automatically add or subtract credit from a venue or liquidity pool. Today, if a client runs short of capacity at one venue, but has spare credit at another, its FXPB will often need to manually top up the credit limit at the first venue to ensure the client can continue trading – in effect, running around the house to redistribute sweets from a full bag to an empty one.

Using an API, FXPBs will be able to add credit automatically if limits are close to being breached. More importantly, they can rebalance between venues – moving spare capacity to where it’s needed, and potentially reducing credit overallocation.

“It means the prime brokers have got more confidence that they can manage their risks appropriately,” says Paul Clarke, head of FX venues at Refinitiv.

PBs under pressure

These developments are the latest attempt to fix a problem that has always existed in FXPB, but has come into focus as banks have been reassessing their PB risk management processes following a series of losses over recent years.

It kicked off with Citi’s $180 million FXPB loss in 2018, which was limited to exotic derivatives instruments, but spurred prime brokers to review their risk policies and practices –including credit overallocation – before regulators did it for them. In Citi’s case, the bank also offboarded some of its riskier clients, including a number of proprietary trading firms.

The March implosion of family office Archegos Capital Management and the subsequent billions of dollars in losses attracted more scrutiny, even though the losses occurred in equity-linked instruments.

Sceptics, though, argue the new credit APIs don’t really fix the main problem – credit will still be overallocated, they argue, and client-level limits will still be checked post-trade. So, a rapid-trading or rogue algorithm could still result in a bank taking on more exposure than it wants.

“Risk management is not just about credit: we’ve seen multiple multi-asset PB losses from a lack of controls,” says David Faulkner, global head of sales at tech vendor Fluent Trade Technologies. “If you do not have the ability to monitor in-flight orders and trading activity being executed in your name, you are running a wide range of risks, not just credit. Post-trade-driven credit APIs will not fully mitigate credit risk. Zeroing down a credit line at a venue for a kill switch, or rebalancing credit, can take seconds. An e-trading system can submit tens of thousands of orders and resulting transactions within that timeframe before being impacted.”

“In-line risk-checking technology exists, and can monitor and prevent any risk event, credit and trading, from happening. Such globally synchronised checks can take place anywhere within the execution path, meaning they can be non-intrusive and be targeted – say, to a certain currency pair or to ‘reduce position only’. Without incorporating this into the existing risk management landscape, I fear we may see yet more wide-ranging risk issues.”

Since last year, a working group of more than a dozen large FXPBs has been discussing ways to more fundamentally free banks from their reliance on overly generous credit limits. The Global Financial Markets Association’s (GFMA) FX division, which is overseeing the working group, is exploring numerous potential fixes, but those talks are understood to be progressing slowly.

We’re keen to see the ECNs using net limit, rather than gross limit, methodologies – at least, for linear products
Victoria Cumings, GFMA

The most radical idea under consideration is the creation of a central credit-limit-checking provider, which would act as a utility through which FXPBs could monitor a client’s aggregate position and where credit could be stored, notified, calculated and replenished. In theory, if all FX limits and trades were also run through a hub, brokers would be able to monitor and limit consumption in something close to real time.

The working group is also looking at less fundamental changes, including the potential for dynamic management of designation notices (DNs) – legal documents that outline the types of products a client can trade, as well as the credit limits applied to the client’s positions. DNs do allow for pre-trade credit checks to see whether a client is within its limits, but can’t tell whether a trade will take them over what’s known as a net open position limit until post-trade.

Traiana’s DN Manager service allows prime brokers to define the type of currencies, products and tenors a client is allowed to trade within its DN credit limits. FXPBs can raise or cut a client’s credit limit via the hub when needed. But changing details of the DNs still requires manual intervention, so the industry is exploring ways to make that more automatic and dynamic, in theory allowing limits to be updated faster and reducing the need for excess credit.

The working group is also promoting greater standardisation of the credit limit choices that electronic communication networks (ECNs) provide as part of their credit administration tools. The methodologies used in credit monitoring differ depending on the venue, and each platform offers its own credit limit choices, such as net exposure, gross volumes and regional limits.

“Certainly, we’re keen to see the ECNs using net limit, rather than gross limit, methodologies – at least, for linear products,” says Victoria Cumings, a managing director for the GFMA’s FX division in the Americas. “I don’t think there’s any secret there, and I understand the ECNs have had that message already, and are working towards achieving that, which is a good thing. Reducing differentiation in the approaches taken to credit limit monitoring by ECNs will translate into benefits for those participating in the FXPB ecosystem, and would be a step in the right direction to support any potential future development of a universally accepted pre‐trade credit check market utility.”

Cumings tells FX Markets there is no single solution that the industry is working towards, and that, while a central credit utility is perhaps a longer-term utopia, it would require changes for all industry participants. In the interim, however, she believes there is probably more the industry could do to better optimise FXPB credit management, such as greater standardisation in methodologies.

Get on with it

Some PB clients and tech vendors believe talks about overallocation are progressing too slowly. Absent the creation of a central credit-checking hub, they believe the technology to properly tackle the problem already exists, and that the PBs just need to get on with it a co-ordinated approach in using a universal technology provider.

“We have the opportunity to use technology that is already out there to mitigate some of these risks that are inherent in the business,” says Noel Singh, head of eFX business development at Sucden Financial, a prime-of-prime broker.

He points to the Cobalt ecosystem – in which Sucden participates – as one path the market could take. In it, the available net open position is based on real-time collateral balances, which is then dynamically distributed to multiple venues, ensuring latency in the pre-trade process is reduced.

Another option could be Fluent, which offers software that can offer pre-trade risk management at the FXPBs or FX platforms, by sitting in the order path and stopping trades being submitted that are over client limits. And, of course, there’s Traiana’s DN Manager service.

It cannot be a big bang. You’re just going to lose 90% of the participants, and that’s the thing we want to avoid
Basu Choudhury, Traiana

One head of FXPB at a bank tells FX Markets there is no existing technology that can completely fix the problem for all participants in the prime-broking chain. The APIs are a start, he says, since they would be able to dynamically alter the DN amounts.

“I’m not worried about the utilisation per se: I’m worried about the dry-powder risk. I’m worried about a client going out and buying $100 million dollars – like, in a rogue fashion – from one bank, and $100 million from another, and another. When you have this real-time API, what you’re able to do is keep that limit much smaller,” says the FXPB head.

There’s also the classic problem of a huge dependency on the existing operational framework – the industry cannot shut off the current approach and instantly adopt a new model. Hence, others believe a gradual approach to fixing the problem will work best.

“It cannot be a big bang. You’re just going to lose 90% of the participants, and that’s the thing we want to avoid,” says Basu Choudhury, head of strategic initiatives at Traiana. He adds that, to get over the hurdles of current fragmentation, there needs to be industry agreement on everything from technology to standardisation.

“In truth, the problem isn’t technology. The issue is you have a bunch of business processes that evolved just because a new participant came along, or a new product came along, or something was added on. What we built met the needs at the time, but we now have the opportunity to redesign in a more efficient and sustainable manner,” says Choudhury.

The PB source believes targeting simple things such as standardisation of credit limit calculations could be one of the most cost-effective ways to help mitigate the problems facing the industry.

“To me, that’s the more realistic way to approach the problem. Get realistic, get goals, set goals that sufficiently address the risk problems and mitigate the risks efficiently,” he says. “Then, figure out the least amount of effort required to get there, and you’re going to have a better chance of success than trying to design the perfect mousetrap.”

Editing by Duncan Wood

  • LinkedIn  
  • Save this article
  • Print this page  

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact customer services - www.fx-markets.com/static/contact-us, or view our subscription options here: https://subscriptions.fx-markets.com/subscribe

You are currently unable to copy this content. Please contact [email protected] to find out more.

You need to sign in to use this feature. If you don’t have a FX Markets account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an indvidual account here: