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If you were to ask a prop firm owner about what they do with ‘client funds’ or whether they ‘segment’ them, I have a feeling a dazed, bovine, expression would come over their face – kind of like if you asked Cole Palmer what he thought about Spinoza’s theory of knowledge.
The basic point is if you are running a prop, you have money coming in, via challenge fees, and then money going out, via funded account payouts. Then what happens? Do you just have a giant pool of cash, which you use to run your business, or do you have a challenge fee account that you use for payouts and a separate one for actually managing your business?
My assumption would be that many firms would not even think about this, hence the dazed expression, and that they just have a big pool to do everything. This is probably why many run into trouble. If you intermingle operational expenses and your fees, it’s easy to lose sight of what your liabilities are. I think this assumption still holds for many firms, but not the ones I spoke to.
According to Adam Bock, Head of Eightcap Challenges, the company keeps client challenge fees segregated with their banking partners. They then have a cash buffer, which is monitored by the risk team and adjusted accordingly, to ensure that any payouts to funded account holders can be met.
“While Eightcap Challenges does not operate in a regulated market and as such is not a regulated investment product, we’re committed to applying strong fund-handling practices,” Bock told me.
“We are operated by a regulated broker and adopt the organisation’s fund management practices. We also operate on the assumption that at some point in the future our simulated trading markets may become regulated and we already conduct our business as if we are. I don’t believe many firms can say they operate in the same way.”
Although they did not go into as much detail, two other prop owners gave the impression they have developed a similar system. Essentially there is a cash pile maintained for payouts, which can be adjusted depending on what is happening in the underlying market.
“We treat prop payouts as expenses, so they are invoices that get paid from opex,” said one prop firm owner. “We keep a healthy buffer in the opex for [larger payouts]. So there is a minimum amount and then an amount relative to revenue.”
What’s interesting about this area, as with prop in general, is there doesn’t seem to be a concrete operational setup. Because the industry is (relatively) new and there are no rules constricting how firms can operate, you don’t have a clearly defined way of managing cash coming in and going out.
At the same time, I think there is a difference between an established player or one with a big backer – like Eightcap – and a newcomer to the market.
To use a parallel, if you are a startup broker, you will struggle if you cannot use client deposits as margin with your LP. If you are a big boss, you have so much money that you don’t have to do that.
In the same way, if you are a massive prop firm, you can afford to have a big cash buffer to manage payouts that is separate from your operational funds. If you are Bucket Shop Funded and just started out, then you can’t do it.
For end traders, looking at this stuff is also important. There is an almost pathological obsession among them as to whether or not a company does pay out and if the payouts are ‘legit’. But there is not so much focus on why the firm would not be able to pay out in the first place.
Bock says that Eightcap funds are kept with JP Morgan and are “segregated, audited and insured”.
I imagine that almost no other firm can say the same for now, but I would not be surprised if this becomes a new marketing tool in the months ahead. It’s like everyone saying they’re an ECN broker 15 years ago. Deja vu all over again.
