Some of the most misleading content you will see on the internet today is around how trading actually takes place at FX/CFD brokers. One key area in this regard is the STP vs A-book debate.
Some providers conflate the two. Others make it seem like there is a huge distinction between them. Others don’t appear to know what they are talking about but make up some article about STP vs A-book anyway.
So in this article we’ll try to provide some clarity on the subject and look at what the difference is between STP vs A-book models.
The b-book model for FX/CFD brokers
Before we look at the STP vs A-book debate, it’s first worth understanding what people mean when they talk about a B-book model.
In simple terms, a B-book model means that an FX/CFD broker is internalizing all of the client flow it gets. Or in really simple terms, it is taking the other side of all the trades that it gets from its clients and never places any trades to offset them.
However, matters get slightly complicated here because when you trade with a retail broker, you are trading in CFDs. These are over-the-counter derivatives. By definition that means the company you are trading with is taking the other side of your trades.
So in theory, all FX/CFD brokers are operating a B-book model in the sense that they are always counterparty to client trades.
This is where A-book and STP models come into play – these are methods that brokers use to offset the risk that is created by taking the other side of client trades.
The b-book model for FX/CFD brokers and natural client offsetting
When you take the other side of client trades, a natural offsetting process takes place.
You can think about this in very simple terms with a bureau de change that you might go to on holiday.
Let’s say that you want to swap $100 for €80. You go to a bureau de change, give them $100 and get €80 back.
Now imagine that immediately after you have done that, someone else comes in. They want to swap euros for dollars. The difference in the spread means that this person pays €85 and gets back $100.
In this example the bureau de change effectively ran the equivalent of a B-book. It took the other side of both your ‘trades’. However, because those trades were the opposite of one another, an offset took place and the bureau de change operator’s profit was the €5 made from the bid-ask spread – the difference between the buy and sell price.
You can apply this logic to a broker. Imagine you have one client that takes a $100,000 long position in Tesla shares. Now imagine that at the same time as that happens, another client takes a $100,000 short position in Tesla shares.
A broker that b-books all its trades will be ‘flat’ on these two clients. It has b-booked both trades but in doing so has also offset them.
Because the broker has taken on equivalent long and short positions, they hold no risk on their book and the money they make from those trades is in the spread – the difference between the ‘buy’ and ‘sell’ price.
This is a simple example and in reality most brokers deal with trade flow that is much more complicated than this. Nonetheless, if you process millions of trades per day then you will end up with a situation where a level of offsetting takes place between your clients, who take opposing positions.
The A-book model for FX/CFD brokers
That leads us into the A-book model for FX/CFD providers.
Imagine a broker that takes in millions of trades every day. As we’ve seen, a lot of that flow will have a natural offset – people make opposing trades that offset each other and the broker captures the spread on those transactions to make money.
But not all of those trades will offset each other. That means the broker will be left with a residual amount of flow that it can either B-book – take the other side of – or hedge out to a liquidity provider.
This is the A-book model. It is when a broker allows client trades to offset each other and then hedges out any residual exposure to a liquidity provider.
To give a simple example of this, imagine you have a situation where a broker’s clients are long $100,000 in gold and short $20,000 in gold.
The long position is far larger than the short position. This means the short position can offset $20,000 of the $100,000 position, so the broker is left with $80,000 in flow that it is taking the other side of.
Because they are taking the other side of a long trade, that effectively means the broker is short gold. If the price goes up, the clients will make money and if it goes down, the broker will make money.
A broker that runs a B-book model will take that risk and not hedge in the underlying market.
A pure A-book broker will not take that risk. They will go to the underlying gold market and hedge their exposure to gold by taking an equivalent position to the one their clients have.
STP vs A-Book – what’s the difference?
An STP broker runs on a different model to an A-book broker.
STP brokers match all trades they get from a client with an equivalent position with a liquidity provider. It’s for this reason that STP brokers are often known as matched-principal brokers for regulatory purposes.
If that name sounds odd, just remember that CFDs are over-the-counter derivatives. That means the broker is taking the other side of any trades you make.
An STP broker will execute your trade but then seek to make an equivalent trade at exactly the same time with a liquidity provider.
So if you imagine going long $100,000 on gold, an STP broker will act as counterparty to that trade but will also look to execute an equivalent, offsetting trade as close to instantaneously as possible.
The key difference here is that the STP broker never takes on any risk. They do not capture spread in the same way that an A-book broker would by allowing client trades to offset one another. Instead they offset all trades they get with a liquidity provider.
This means that an STP broker has to make its money in other ways. That could include swaps, mark ups to the spread, or trading commissions. They may also have an agreement with their liquidity provider to get rebates from the trades they execute with them.
STP vs A-book: the reality
If you’ve managed to make your way through this article and have actually understood what we are talking about, then we apologise for the following…
Everything we’ve said so far is highly theoretical and doesn’t often exist in reality.
Why is that?
The truth is that most brokers that run an A-book will also have a certain level of risk tolerance.
They are happy to B-book their clients’ trades but only up until a certain point. If the risk they are exposed to goes beyond that point then they hedge in the underlying market.
In that sense, it’s fairer to say that what people describe as an A-book model is more likely to be a hybrid model – some trades are internalised, even after any offsetting has taken place, and some are hedged out to a liquidity provider.
STP brokers are slightly different. These do exist and there are regulatory licences that only permit brokers to operate with this model.
However, a couple of other factors need to be considered here.
One is that an STP broker can send trades to an entity with the same owner. That might be for tax reasons or because they want a lower regulatory burden. Whatever the case, even if the entity that has the STP licence is operating with an STP model, it’s entirely plausible its own group entities are still taking the other side of the trade.
So while in theory the broker may be operating an STP model, in practice the broker is just sending flow to another group entity, where they will either B-book everything or manage their flow with the hybrid model described above.
The other factor is one mentioned above. An STP broker may have a rebate agreement with its liquidity provider. That means it receives rebates for trades it executes with its liquidity provider, meaning the client loss is, in practice, still gained by the broker. So although the broker is operating an STP model, it is still gaining from client losses.
Simple, right?