The simplest way to understand what a prime of prime is for FX/CFD brokers is that they act like a broker to brokerage companies. That doesn’t capture exactly what they do but it should give you a rough sense of it.
Prime of primes provide pricing, liquidity, and other trading services to retail FX/CFD brokers, much as FX/CFD brokers provide pricing, liquidity and other trading services to retail clients.
Prime of primes fulfil an important role in the FX/CFD industry as a result. They provide the pricing that FX/CFD broker clients trade against. They also provide services that enable FX/CFD brokers to hedge out their exposure.
Why are they called prime of primes?
The phrase prime of prime is derived from the phrase prime broker. Like a prime of prime, the simplest way to think about a prime broker is that it provides the same sort of services a broker does but instead of dealing with retail clients, it serves hedge funds and asset management companies.
Prime broker businesses are typically offered by investment banks. Goldman Sachs and Morgan Stanley, for example, have prime broker divisions that serve hedge funds and other financial institutions.
That means they’ll do things like clear their trades, manage the custody of their assets,and provide them with access to leverage when trading in certain asset classes.
Prime brokers can also vary in terms of what services they offer. Clients may also only choose to access certain services. For example, there are FX prime brokers that only service clients wanting to trade currencies. Similarly, a hedge fund may use a prime broker but then only use its services to trade in the futures markets.
Because prime brokers tend to be operated by large investment banks that are often risk averse and highly regulated, they typically only take on clients that have a large amount of capital. For instance, a hedge fund may need a minimum of $100m of assets under management to open a prime broker account with an investment bank.
This is where prime of primes come into play. Prime of primes exist as a stopgap between prime brokers and companies which want to access prime broker services, but which do not have the financial means to do so.
A prime of prime will have prime brokerage relationships with a large prime broker. It then onboards clients, like FX/CFD brokers, that want access to those services, but don’t have the capital to do so.
What do prime of primes actually do?
A prime of prime typically takes pricing from a prime broker and then uses that to provide a price for its own CFD products. It will then provide that pricing to a FX/CFD broker.
In some cases, the FX/CFD broker then takes the price feed from the prime of prime and adds a mark up to it by widening the spread. Regardless of whether or not they do this, the prime of prime’s price feed is then what the FX/CFD broker’s retail clients see on their trading platform or trading app. It is also this pricing that they trade against.
In effect, a true prime of prime is a CFD liquidity provider. They create a price for a CFD product based on the pricing they get from their prime broker. They distribute that price to FX/CFD brokers and then act as counterparty to any trades that those FX/CFD brokers place with them.
In broad terms, an FX/CFD broker’s interaction with a prime of prime is likely to fall into three different categories…
- Matched principal relationship
Some FX/CFD brokers choose to simply pass through all their trades to a prime of prime. In other words, the FX/CFD broker takes the other side of its clients trade but then immediately offsets it with a matching trade that they place at their prime broker.
This is why this model is usually called a matched-principal brokerage. The FX/CFD broker is acting as principal by trading against the client. However, they match that trade as quickly as possible with a prime of prime.
- B-book model and prime of prime
Some brokers purely use the price feed that a prime of prime gives them. They use that feed to create their ‘own’ price for the products they offer clients and then take the other side of all client trades, with no offsetting trades placed with the prime of prime.
- The hybrid FX/CFD broker model
A lot of brokers use a hybrid model. In this instance, they internalise some of the trade flow they get from clients. Typically they will take on a certain level of risk but won’t go beyond it. After they hit that limit, they place trades with their prime of prime broker to hedge out their risk.
As one final point, it’s important to note that prime of primes are likely to be doing exactly the same with the trades they receive from FX/CFD brokers. In most cases they will run the third hybrid model. They take the other side of some trade flow but then hedge out to their prime broker if they have breached a risk limit or simply want to offset their exposure for some other reason.
FX prime brokers and prime of prime
One of the most common claims you’ll see made by prime of primes active in the FX/CFD industry is that they have ‘Tier-1’ relationships with banks.
The ‘Tier-1’ phrase is effectively a marketing term used to describe the leading investment banks that offer prime broker services. For example, Goldman Sachs would be considered a ‘Tier-1’ investment bank that provides prime broker services.
The reason prime of primes like to make claims about having a relationship with ‘Tier-1’ firms is really the result of the fact that a large segment of the FX/CFD industry used to only offer currency trading.
This has led to the widespread use of the phrase ‘FX/CFD’ – despite the fact that companies offering currency trading are just offering CFDs on currencies. So widespread and mainstream has this phrasing become that we use it on this website just so people know what we are talking about. Confusing, we know!
Anyway, the reason prime of primes like to tout their ‘Tier-1’ relationships is because, in theory, having an FX prime broker relationship with a major investment bank means you can access the best pricing in currency markets. That pricing can then be passed on via the prime of prime to the end retail FX/CFD broker. As FX/CFD brokers want to compete on price, this can be a major competitive advantage to them.
Claiming that you have a ‘Tier-1’ relationship makes much less sense in the context of trading stocks or futures contracts on commodities and indices. That’s because these are exchange-traded instruments, so there is transparent pricing that is on exchange. Currencies are traded over the counter, meaning FX prime brokers arguably have something of an edge in the market, as they have better access to pricing sources.
Prime of primes and misleading marketing
In the FX/CFD world industry, the prime of prime term has been further confused by the fact that there are lots of companies that do not have a prime broker relationship with an investment bank but still call themselves prime of prime.
What tends to happen in these instances is that a company will partner with a prime of prime. They then take the prime of prime’s pricing and feed it to their own base of FX/CFD broker clients. In most instances, they will then take the other side of any trades that those FX/CFD brokers send to them.
If this sounds weird then, yes, it kind of is. You effectively have a chain of companies that are all acting like brokers to each other. An investment bank sits at the top with a prime of prime beneath them. There are then companies below the prime of prime who use its services but then provide the same services to FX/CFD brokers.
You may ask why a FX/CFD broker would partner with one of these companies when they could just go directly to the prime of prime. The reason is basically exactly the same as to why a FX/CFD broker may not be able to go directly to a prime broker – it’s too capital intensive.
For example, some prime of primes won’t work with offshore FX/CFD brokers. But many of these prime of prime of primes (or whatever you want to call them) will do that.
It’s also plausible that one of these companies will offer better trading terms than a prime of prime. For example, they may ask for less margin than a prime of prime, which frees up capital for the FX/CFD broker that they can put to use elsewhere.
Ultimately these prime of prime offshoots use the ‘prime of prime’ phrase for marketing purposes. But it’s important to recognise that they also provide a service that is often needed. Just as a prime of prime enables a FX/CFD broker to access prime broker-like services, so too do these offshoots of prime of primes allow other brokers to access prime of prime-like services.
Prime of prime rebates
One other key part of prime of prime model, regardless of where the company sits on the food chain, is rebates.
When a FX/CFD broker partners with a prime of prime, they will place trades with them – either because they just pass through all their trades or because they are offsetting their risk exposure.
When this happens it is not uncommon for the prime of prime to send back a part of the profit it makes by taking the other side of those trades.
This isn’t always the case. However, it is often one of the factors that drives business for the prime of prime. If they give higher rebates to their clients, they may be more likely to trade with them.
It’s also important to note that this is why the matched-principal model can seem to create more of a conflict of interest than it might seem. If a FX/CFD broker offsets all its trades but then shares in the profits those trades generate, it is still gaining from the client’s loss.
Prime of primes – lots of marketing, not that complicated
Prime of primes in the FX/CFD world are basically brokers to other brokers. They provide the pricing and hedging tools that allow FX/CFD brokers to operate.
In its ‘true’ form a prime of prime should have a relationship with an investment bank’s prime broker division. The reality is there are now loads of companies that use the ‘prime of prime’ phrase to describe themselves when they are actually just using a prime of prime themselves to offer their services.
However, these companies do serve a purpose – even if their marketing can feel rather gimmicky – by providing prime-like services to smaller brokers that can’t meet the requirements of prime-of-primes.
