- Website or Company?
- The History of the Company and its Website
- Broker or Dealer?
- Who pays for the Leverage?
- Liquidity and Spread
- Aggregation of Liquidity – Suppliers and Service Providers
- Who Executes Orders?
- License and Audit – How can Clients Benefit and Where is the Money Kept?
01. Website or Company?
It’s not the website itself, which provides service – it’s the company, which owns the website and has a legal status and the right to provide this type of services.
Sites and domains are not legal entities. They belong either to individuals or legal entities. If the website is owned by an individual, it will be difficult to prove that the service has been provided by the company.
It’s also important to keep in mind that a company has a history, which must be accessible to the public, and a reputation, which has to be justified.
02. The History of the Company and its Website
When signing a service contract, be sure to pay attention to the date of incorporation of the company. It is this date that corresponds to the actual date of founding of the company, and not the date of the website registration, which could have been carried out earlier by another company unassociated with the current one.
You may request a registration statement for the company to see its date of incorporation. The next step is to make sure of the state of the company, by requesting either links to the websites of public authorities at the company’s place of incorporation or relevant documents (e.g. certificate of good standing).
If you want to check the website history and find out when the first content appeared on the website, i.e. when the website began to work, use the link http://web.archive.org. This will indicate the period when the company began to provide services through its website.
03. Broker or Dealer?
A broker is a legal entity, who carries out client orders for the purchase and sale of financial instruments on a stock exchange/site at the client’s expense. In this case, either the client’s money is stored in a separate account, or the broker is not authorized to handle money from clients at all.
The broker must provide information on where exactly client orders are executed (trading platforms, names of the main brokers and dealers executing a trade) in the so-called execution rules. Normally a broker does not provide its own trading platform, but makes available the platform of some other company and acts as an agent (in this case a broker must have a license to be an agent).
A dealer is authorized to accept money from individuals and transfer it to its own account from which it buys and sells securities for its clients. A dealer has the right to manage risks and make final decisions on the execution clients’ orders (if it possesses a principal certificate). The dealer generally provides customers with a trading platform (for example, the popular MetaTrader platform from MetaQuotes). Companies that provide Forex trading services and have a license agreement with MetaQuotes are generally classed as dealers. Companies offering a white label program in relation to the product are brokers.
04. Who pays for the Leverage?A company charges fees for providing leverage. Like any credit institution it charges interest at a given rate for each day this loan is used. In our case it’s called SWAP. Intraday leverage is provided free of charge. Leverage is offered under the same terms and conditions as provided by the prime broker with additional commission possible.
05. Liquidity and spread
The higher the available trading volume in lots and millions for purchase and sale (liquidity volume), the bigger the spread. Vice versa, the smaller the spread, the lower available liquidity. Financial markets differ in this way from the usual markets of goods and services where the more goods you buy the better price you get.
In a professional environment, a trading conversation usually starts with the volume, meaning your desired average trading volume under normal trading conditions. If you have a high volume, for example several hundred lots (tens of millions), the spread is usually wider. This is because covering this amount will require more than one offsetting order from the order book (which shows all bid/ask orders with volumes).
The spread displayed on a terminal has in fact been calculated for the smallest available volume from the order book, i.e. for the initial offsetting orders. However, the final spread is determined from the calculation of weighted average prices taking into account so-called slippage. If a company has several liquidity providers, then its slippage is usually less than companies with only one provider at the same level.
Many companies offer a fixed spread. In this case possible slippage risks have been considered beforehand, so fixed spread may be higher than the average floating spread of the market. However, these conditions are usually offered for deliberately low volumes (for the appropriate target market).
If a dealer claims a small spread for a large volume, your orders will be most likely executed with slippage (i.e. wider spread). This practice means that dealer’s activity lacks transparency, because in this case clients cannot calculate and assess their fees to the dealer prior to the trade.
To avoid this, a client should ask for Volume-Weighted Average Price (VWAP) data, or slippage statistics for a given volume of transactions at a known average spread at a particular time.
06. Aggregation of Liquidity – Suppliers and Service Providers
Liquidity can be aggregated from multiple providers, including prime brokers or from the banks directly. Prime brokers in turn also work with either larger prime brokers or directly with banks. Through this interaction access is provided to the interbank market.
A liquidity aggregator is special software that aggregates prices from different liquidity providers, giving you depth of liquidity and allowing you to choose the best price. These services are offered by companies such as Integral, Currenex, HotSpot, etc. These companies either organize trading or provide trading technologies, but they are not liquidity providers themselves (apart from certain exceptions). Ultimate liquidity is usually provided by the banks. Prime brokers act as mediators, offering their own trading conditions for this liquidity.
There can be a whole chain of brokers before you get to the providers of ultimate liquidity, in the so-called Prime of Prime (PoP) category. Each member of the chain seeks to earn commission.
If a participant of an organized trading platform, for instance Integral, passes orders straight to the liquidity provider (prime broker) through the organizer (using the organizer’s technology), this means that an STP or “Straight Through Processing” model is applied.
On the other hand, if a participant of an organized trading platform, say Currenex, places orders in the order book of the organizer of the trades, the organizer then acts as a market maker. The organizer then reports to the participant and provides data on where the order has been executed. When all market participants use this principle of work, a fair and equal trading environment is achieved, called the ECN – “Electronic Communication Network”.
07. Who Executes Orders?
A dealer executes transactions itself. It has the right to not disclose the final executors of transactions (acting as an actual counterparty in the transaction), and can limit information to naming only the prime brokers with which it works.
Brokers usually report the transaction history – where each transaction has been executed and who acted as a counterparty in the transaction.
The STP model is typical for brokers. It can be used by dealers too, as it simply depends on technology, and not a specific business model: a business model is characterized by a license agreement (see “Broker or Dealer”). In other words, the dealer has the right to use STP transactions in order to determine final execution prices of a liquidity provider, but makes the final decision on transaction execution itself (the so-called auto-confirmation at the bridge level or riskbook type of execution at the level of a liquidity aggregator).
08. License and Audit – How can Clients can Benefit from it and where is the Money Kept?
A license facilitates working with a number of major banks (such as Bangkok bank, OCBC Bank, Novo Banco etc.) to provide customer service. Without a license it is almost impossible to open such accounts in a respected bank. A license also means the possibility to connect to the major brokers in the U.S. and the UK (starting e.g. from FC Stone, Sucden Financial and Cantor Fitzgerald till the highest level – e.g. JP Morgan, Rabobank, Morgan Stanley, UBS and Citi). Accordingly, if there is no license, company can’t connect major banks and brokers.
If a company has a license, it means that it has passed an audit and its activity is authorized and fully legal. As a rule, most of the important regulators only accept audits done by major auditors like Deloitte, Ernst & Young or PriceWaterhouseCoopers. If a company’s activity is examined by an external auditor on a regular basis, it means that a company is being monitored financially and that potential risks (like a low level of reserve capital) are being assessed, so that a company will be given useful recommendations (like increasing reserve capital) ahead of time.
Having a license requires segregation of client funds. In other words, clients’ money must be held in separate bank accounts to ensure its safety in the event that the company went bankrupt. This guarantees that in such a case clients will get their money back. The company has no right to use this money for any other purpose.
Paying attention to the issuer of the license is important. The issuer can only be a public agency, authorized by the government, which guarantees the legal protection of investors’ interests. No other organizations have such powers.