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Prime of Prime (PoP) Definition

What Is Prime of Prime (PoP)?

Prime of Prime, or PoP, is a agency that gives a retail dealer (typically forex brokers) with entry to the buying and selling liquidity pool of the larger banks. These huge banks are known as tier 1 banks, and never simply anybody can commerce immediately with them.

Key Takeaways

  • A Prime of Prime (PoP) dealer is one which has an account with a tier 1 financial institution, and lets retail brokers commerce by way of that account so the retail dealer can entry the tier one financial institution’s liquidity.
  • Buying and selling immediately with a tier 1 financial institution and accessing its liquidity is troublesome for people and small companies, so the PoP bridges the hole and gives the smaller participant with entry.
  • To be able to appeal to enterprise, PoP brokerages and their related retail brokers sometimes supply larger leverage and smaller commerce sizes than a main dealer.

Understanding Prime of Prime (PoP)

Prime of Prime (PoP) are labeled as tier 2 brokerage companies. Tier 1 is the brokerage arm of enormous banks that enable institutional merchants and prospects to commerce with the financial institution. Tier 2, or PoP, can greatest be described as a brokerage agency that has an account with the tier 1 brokerage agency and permits its prospects to commerce with them.

PoP leverages their entry to tier 1 banks to arrange entry for the retail dealer, which may join their smaller retail consumer orders with the bigger orders of the tier 1 financial institution. Nonetheless, most PoPs is not going to deal immediately with people—the retail brokers do this. The retail dealer handles particular person purchasers and tries to draw extra enterprise.

Tier 1 banks are typically risk-averse, and subsequently demand strict monetary protocols and risk management from their purchasers. A retail dealer might not meet these inflexible requirements and subsequently might not be capable to commerce immediately with the tier 1 financial institution. PoP does meet these requirements, is a consumer or associate with the tier one banks, and permits the retail dealer to commerce by way of them with the tier 1 financial institution.

Because the PoP already meets the requirements the large banks are searching for, the retail dealer utilizing the PoP will sometimes supply larger leverage to its merchants, and permit them to position smaller sized trades than what can be obtainable if buying and selling immediately with a tier 1 financial institution. They do that primarily to draw enterprise since their retail purchasers might not have the funds to position the bigger transactions that tier 1 banks require. Nonetheless, the bid-ask spreads could also be wider than what tier 1 banks supply. The primary motive for that is that this is among the primary ways in which PoPs generate profits.

One of many causes that tier 1 banks and prime brokers do not present the providers that PoPs do is that there’s a smaller profit margin within the smaller trades which usually come from a retail consumer and their dealer. Moreover, their techniques typically do not help a cheap technique to full smaller trades. PoP brokerages are additionally geared up to cope with growing regulatory necessities for extremely leveraged trades.

Prime of Prime Brokers in Motion

Shoppers will use a PoP service for quite a lot of causes. Firstly, it gives entry to extra liquidity, which is essential for merchants. Secondly, PoP provides merchants entry to merchandise that normal prime brokerage accounts do not supply corresponding to non-deliverable forwards (NDF). 

The PoP construction got here underneath scrutiny in January 2015, when the Swiss National Bank (SNB) eliminated its three-year-old peg of 1.20 Swiss francs per euro. Because of this, the euro and Swiss Franc forex pair (EUR/CHF) dropped from 1.20 to an intraday low of 0.85, a roughly 41% drop. Many of those purchasers had been leveraged of their positions; contemplating the pair dropped 41% after the announcement, this resulted in main losses for a lot of purchasers.

This occasion noticed PoPs elevate the quantity of funds wanted in its buyer’s accounts for capital necessities, together with different danger administration protocols being enforced.

PoP Instance

Retail foreign exchange brokers are typically purchasers of PoP. When these entities begin out they’re too small to deal immediately with the large banks and entry their liquidity. For that reason, they may search out a PoP dealer that can hyperlink them up with the large banks.

By linking to the large banks, the retail dealer is ready to entry stay worth quotes from the foremost banks which they then supply, after widening the unfold, to their purchasers. These retail purchasers can then commerce on these costs. This is able to not be doable if the dealer did not hyperlink up with the tier 1 companies.

The retail dealer might mark up the spread that they obtain from the tier 1 banks. For instance, the uncooked tier 1 unfold on the EUR/USD could also be 1.12565 (bid) / 1.12567 (ask), however the charge Pop purchasers could also be is 1.12563 / 1.12569. The added 0.00002 on both facet of the tier 1 unfold generates income for the PoP. That is supplied to their purchasers, just like the retail foreign exchange dealer, who then add an extra markup on to this and supply it to their purchasers. So, the retail consumer might even see a EUR/USD quote of 1.1256 /1.12572.

This markup within the unfold is a method that PoPs and retail foreign exchange brokers make their cash. Different methods embody charging a commission on every commerce.

Usually, the extra PoP accounts or hyperlinks to the large banks a retail dealer can get, the higher. Liquidity from 5 huge banks is significantly better than liquidity from just one. The extra tier 1 banks offering the retail dealer with quotes and volume, the decrease the retail dealer’s spreads might be, all else being equal. For this reason foreign exchange brokers promote how a lot liquidity they’ve entry to and which huge banks are offering it.

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