Being successful in the foreign exchange prime brokerage (FXPB) industry often means not being noticed. Electronic systems seamlessly communicate, exceptions are handled promptly, and clients don’t exceed risk limits.
But when Citi’s FXPB, one of the largest on the street, announced it had taken a $180 million hit last year, the industry’s risks came crashing into the open. The losses came as a shock to the industry, and spurred questions internally about how safe the business really is.
Clients were also looking for reassurance. They “want to see that we’re here and stable and able to provide them new services in the long term”, says Brian Horgan, global head of prime and derivatives clearing risk at HSBC.
HSBC believes it can be that secure counterparty, and at the centre of the broker’s risk management strategy is its client selection process and approach to the business.
The business runs real-time risk monitoring, which allows it to know immediately how market moves will impact clients and address issues quickly. Clients can also access real-time insights on their margin and risk limits, says Vivek Sarohia, global head of structuring for forex prime brokerage at HSBC.
“It allows us to then have those meaningful conversations as close to real time as possible rather than having to wait 24 hours to determine how a client will be able to navigate through a particular scenario,” says Sarohia.
The broker’s 52 clients, a majority of which manage over $10 billion, comprise hedge funds and asset managers; firms the broker sees as having synergies with its broader forex trading business.
After Citi showed high-frequency trading shops the door in June, some banks jumped at the chance to snap up new business, but HSBC was wary. Gemma Laman, global head of sales at the bank’s forex prime brokerage, says new opportunities lie more in the hedge fund and asset management space.
“You want to really look at which clients from a long-term perspective make sense for us and for them. [The goal is to] become that central partner to them rather than just a clearing provider to them,” Laman says.
Part of building that partnership involves leveraging clients’ existing relationships with the bank to avoid siloed interactions and offer a fuller range of services.
“HSBC in particular have been quite good in terms of joining up their sales relationship with their prime offering,” says an operations head at a large hedge fund and client of the prime broker.
“The fact they’ve seen this as a single relationship – rather than sales talking to our portfolio managers versus prime talking to operations – I think has helped because it means that the relationship front to back is one that they’re keen to grow.”
The broker uses its relationship with its forex trading desk to better understand market liquidity, especially in emerging markets, and help gauge incoming risks. The team also shares the same pricing technology as the desk to value instruments, but maintains a separation between the two businesses.
For the FXPB business, the new initial margin requirements are a challenge, given most of the business remains non-cleared.
A large portion of the brokerage’s clients were captured in September’s fourth phase of the non-cleared margin rules, which required firms trading over $750 billion in aggregate average notional amount (AANA) of non-cleared derivatives to post initial margin on new trades.
Margin is based on exposures so, to help optimise client portfolios, HSBC worked with technology provider Capitolis to novate options trades across counterparties to flatten risks. The UK bank also developed its own compression service in-house, which helped reduce client gross forex exposures by between 50–80%, depending on the particular client strategy, says Sarohia.
We’ve got a great insight from an FXPB perspective as to how our clients with forex strategies have been impacted by the rules
Vivek Sarohia, HSBC
The broker says its experience with these firms newly captured by the regulation will help when the upcoming September 2020 and September 2021 phases bring into scope firms trading more than $50 billion and $8 billion of AANA, respectively.
“We’ve got a great insight from an FXPB perspective as to how our clients with forex strategies have been impacted by the rules, which also means then that we are in a great position to educate our clients who will be captured in further phases,” says Sarohia.
The debate about pricing of FXPB services after Citi’s fall and in the new world of initial margin is still a live one, and Vincent Bonamy, head of global intermediary services for forex and commodities at HSBC, agrees it’s a challenge.
“As an industry, we need to come up with a more accurate way to price our services,” says Bonamy, adding that he believes they have got it right.
Clients say they are pleased with the pricing on offer at HSBC. The hedge fund operations head says the UK bank’s competitive rates and large balance sheet made its offering attractive.
“They were seemingly happy to take on some of the size of book that we’re running without potential constraints around balance sheet usage,” says the operations head.