Prime of Prime (PoP) Brokers Explained
A Prime of Prime (PoP) broker links retail brokers with tier 1 banks. Retail brokers trade through the PoP broker's account, gaining access to the tier 1 bank's liquidity. This benefits smaller players who struggle to directly trade with tier 1 banks. PoP brokers offer advantages like higher leverage and smaller trade sizes to attract business from both retail brokers and their clients.
Basics
Retail brokers, commonly forex brokers, gain access to the larger banks' trading liquidity pool through a PoP broker, abbreviated as PoP. These major banks are known as tier 1 banks, and direct trading with them is limited to specific entities.
Prime of Prime Main Aspects
Prime of Prime brokers fall under the tier 2 category of brokerage firms. Tier 1 represents the brokerage arm of major banks, catering to institutional traders and clients seeking to trade directly with the bank. On the other hand, tier 2, or PoP brokers, serve as intermediaries with an account at a tier 1 brokerage, enabling their clients to engage in trading.
PoP Brokers & Tier 1 Banks Relationship
PoP brokers capitalize on their relationship with tier 1 banks to facilitate connections between smaller retail orders and the substantial orders of these banks. While PoPs rarely engage directly with individual traders, they collaborate with retail brokers who handle these clients and strive to expand their business.
PoP Brokers Advantages
Given PoPs' alignment with the standards of major banks, retail brokers utilizing PoPs often offer increased leverage to traders and permit smaller trade sizes, which is especially attractive to retail clients lacking the capital for larger transactions demanded by tier 1 banks. However, these favorable conditions might come with wider bid-ask spreads compared to tier 1 banks, contributing to the revenue generation for PoPs.
Tier 1 Banks vs Prime Brokers
The distinction between PoPs and tier 1 banks or prime brokers arises from the narrower profit margins associated with smaller trades, which are typical of retail clients and their brokers. Additionally, the systems of tier 1 banks and prime brokers are not always optimized for the cost-effective execution of smaller trades. PoP brokerages are equipped to navigate evolving regulatory demands surrounding highly leveraged trades.
Requirements for Tier 1 Banks
Tier 1 banks maintain a risk-averse approach, demanding stringent financial protocols and risk management from their clients. Retail brokers might not always meet these strict criteria, hindering them from trading directly with tier 1 banks. PoP brokers, having met these requirements, act as clients or partners of tier 1 banks, enabling retail brokers to trade through them.
Example
Retail forex brokers use PoP services to access major banks for liquidity. PoP brokers link these smaller entities to significant banks, enabling them to offer real-time price quotes to clients after widening the spread. The PoP adds a slight markup to the tier 1 spread, generating revenue. This is extended to retail clients through further markups. Additionally, PoPs and forex brokers profit from trade commissions. The more connections a retail broker has with major banks, the better their liquidity. Multiple tier 1 banks quoting prices and volume lead to lower spreads. Hence, forex brokers highlight their liquidity access and partner banks in their promotions.
Conclusion
Prime of Prime brokers offers an intermediary service to retail brokers and smaller market players, facilitating their access to the liquidity of tier 1 banks. PoP brokers typically offer advantages such as higher leverage and smaller trade sizes to attract business from retail brokers and their clients. While PoPs rarely engage directly with individual traders, they collaborate with retail brokers who handle these clients and strive to expand their business.