A couple of quick notes before beginning this week’s piece. One is that I have been short of time over the past week, so today’s article is more like an edited set of notes (as opposed to the illustrious prose I know you’ve all come to expect from CFDs Weekly).
The other point is that, reading this article back again, I realise it isn’t a great look to not name anyone that I have spoken to. Unfortunately almost no one I speak to when writing CFDs Weekly will speak on record. This does make naming people hard!
Lastly, I wrote a while ago about having a meet up for readers. The date for this will be October 13th with the place to be confirmed (pub in the city somewhere, suggestions welcome). If you’re interested in coming then message me on LinkedIn or email me at david@cfdsweekly.com.
And now on to this week’s piece…
Speaking to an executive at one broker a couple of weeks ago, he made the claim that liquidity provision agreements are entirely down to relationships. If you have a good sales person, he argued, then you’ll get lots of business.
There is probably an element of truth to this but it’s unlikely to result in long-lasting deals. As much as you may like the person you are working with, if their company’s services are rubbish then you aren’t going to keep using them.
So why does a broker choose to use a given liquidity provider (LP) and not another? From the outside this is a difficult question to answer. Visit the website of any LP and you’ll be given a very similar set of selling points, usually something along the lines of… “We’re swimming in ocean-deep liquidity from our tier-1 bank PB connections, which you can execute against in microseconds via our LD4 data centre connections using our boutique FIX API.” Something like that anyway.
As a result, browsing through the LP space feels a lot like trawling through retail broker sites – you have a lot of people all doing something that feels very similar. And yet some differences do remain.
From discussions with several providers, it seems that one – which is fairly obvious – is the set of products on offer. Some LPs may be ‘strong’ in one set of products but poor in another. Alternatively, they may offer access to a more limited set of products and thus be unappealing to a broker looking for ‘more’.
However, having a broader set of products doesn’t necessarily equate to better service. Indeed, an executive at one LP, which offers a more specialised set of products, noted that some prospective clients had gone with other providers because they had a broader offering, only to come back to his company not long afterwards.
It’s a similar situation with pricing and filling orders. Like most things in life, better pricing may often be because the service on offer is poor. Two LPs that I spoke to noted that, although they were not the cheapest service on the market, clients were happy to use them because they believed the service justified doing so.
Similarly, providers that offer ostensibly ‘great’ pricing allegedly often fail to actually fill orders, meaning that their offering may look good on paper (or the computer screen?) but isn’t in practice.
Another area that almost every LP I spoke to highlighted was toxic flow. The problem here seemed to be less about the order flow itself but how LPs responded to it. For instance, an executive at one broker noted that he had been in a position where his LP had shut his company off with no warning.
This may have made sense from the LP’s point of view but was also rather short-sighted. Shutting off a broker with no warning means that they will probably never use your services again. In contrast, actually building up a rapport and trying to understand why your broker is sending you that flow, and providing warnings if need be, seems like a better route to take.
The same is, according to the LPs spoken to, true of credit. Some LPs are, again understandably, not particularly flexible about the credit they offer to their clients. But as with the broker getting shut off with no warning, if an LP makes a margin call and then closes out a broker’s position(s) without much communication, then the broker is unlikely to do business with them again.
That also speaks to a wider point about customer service. Some LPs allegedly provide no access to their trading desk and force brokers to always go through a sales person. Not only is it very likely that this person may not be available when something has gone wrong but they may not have the technical knowhow to immediately respond to a query. In short, and banal as it sounds, actually providing good customer service and speaking to your clients is likely to make you more attractive as an LP.
The two other areas that LPs highlighted as being attractive to brokers were tech and what is probably best broadly defined as ‘brand’.
With regard to the latter, brokers are apparently looking at things like a company’s balance sheet and credit risk, how their money is going to be handled, and both where they’re regulated and where most of their employees are based. In a couple of instances, it did seem as though brokers were opting to work with an LP almost entirely because of their reputation, however vague that may seem.
On the tech side of things, the main points seemed to be ease of use and accessibility. In other words, looking at how simple it is to connect to the LP and how straightforward it is to use their systems. The other point here was on things like managing order flow and looking at ways to increase its profitability. However, this seemed dependent on whether or not a broker already had these sorts of tools in place.
A couple of years ago, I had to write a piece for my previous employer, looking at how much a regular person should be trying to invest each month. The problem, of course, is that each individual is different and so it’s almost impossible to give a precise percentage – not to mention market conditions and other factors. Nonetheless, some guy from KPMG sent me hate mail demanding to know what proportion of his paycheck he should be putting into meme stocks every month.
This piece ended up being similar. Going to iFX or FMLS, you see so many LPs with booths and I’d always wondered why a broker would want to go with one over another. But speaking to brokers and LPs, it seems there isn’t a single answer. Like the ‘regular’ investor, each broker has its own idiosyncrasies and will want different things as a consequence. In the end, they’ll probably just go for whichever LP can cater to their needs.