Why is Diversifying FX Liquidity Providers so Important for Forex Brokers?

In the Forex world, price matters. On an average day, the Forex market processes more than 6B dollars worth of transactions. As the market is so large, the competition between Brokers is also intense. Therefore, for a Forex Broker, a liquidity provider is an important element of the puzzle.  

Additionally, news in the forex space travels fast. Service interruptions – no matter how small – can cause financial and reputational damage for Brokers. Because there are so many of them to choose from, clients can easily drop one platform in favour of another. 

As a result, Forex Brokers are keen to diversify their sources of liquidity. Having access to multiple Forex liquidity providers, they can pick and choose the lowest prices for their customers. Some Brokers may even combine their Forex liquidity providers into an automated aggregator that chooses the best rates automatically. According to the investment banking giant HSBC, forming an aggregator should “lead to improved liquidity, a narrower spread…and, therefore, a better price.”

However, not all Forex Brokers are created equal. Each has a unique set of needs. For some, working with a single liquidity provider may be a better option than working with many. For others, however, the opposite is true.

When is it better for Forex Brokers to choose a single liquidity provider? When is it better to diversify the pool of Forex liquidity providers that they are working with?

Working with a Single Liquidity Provider is Cheaper, but Could Be Riskier

There are several key advantages that come along with partnering with just one liquidity provider. Perhaps the most significant one is that it is cheaper. It can be a better option for Brokers who operate primarily as market makers. These Brokers may only be required to hedge part of their clients’ positions. If this is the case, their needs could theoretically be satisfied by almost any single supplier. 

However, depending on one liquidity provider means that the Broker is at the mercy of that provider. Therefore, if it is facing issues, they will have to face consequences. What is worth mentioning, it can take weeks (or months) to connect with a new liquidity provider.

Working with Multiple FX Liquidity Providers Can Reduce Financial and Reputational Risks for Forex Brokers

Working with multiple FX liquidity providers can provide Brokers with additional security. Perhaps that is why such a trend seems to prevail in the market. According to Andreas Kapsos, CEO of Match-Prime, a liquidity provider regulated by CySEC:

Andreas Kapsos, CEO of the regulated liquidity provider Match-Prime
Andreas Kapsos, CEO of Match-Prime Liquidity

“Working with a diversified set of FX liquidity providers may be particularly important for Brokers who provide their clients with access to interbank liquidity. In other words, a Broker that acts as an intermediary for its clients’ positions requires a reliable liquidity provider that offer tight spreads and low commissions.

These kinds of Brokers may be particularly sensitive to any issues the liquidity provider may have. For example, if the liquidity provider begins to have banking problems, or if there is a technical failure that causes service interruptions, the Broker will have to face consequences. These are usually not purely financial – they can also affect its reputation.

Forex Brokers should take their appetite for risk as well as their unique set of needs into consideration before deciding whether or not to diversify the pool of liquidity providers that they work with.”

In the Forex world, Quality Is King

Of course, quantity does not necessarily equal quality: more FX liquidity providers do not necessarily mean better quality of service. Working with a single Tier 1 liquidity provider may be a better choice than choosing several lower-tier providers. These “Tier 1” FX liquidity providers include large investment banks and other financial institutions with extensive foreign exchange departments. Most of them offer their customers the tightest spreads for the currency pairs that they offer market-making services for. Therefore, a Forex Broker working with a Tier 1 liquidity provider should theoretically have access to the lowest prices on the market.

When choosing a liquidity provider to partner with, Brokers should take several things into consideration. These include:

  • Spreads – Does the liquidity provider consistently provide narrow spreads? What factors generally affect the width of the provider’s spreads?
  • Fill ratio –  On average, what is the percentage of orders that the liquidity provider is able to successfully fill?
  • Last look hold time – How long will the liquidity provider’s price quotes be valid before they expire?
  • Market impact – What is the effect that the liquidity provider has on the market of a given currency pair?

Once the Broker has a solid understanding of all of these criteria, it will be able to make a decision. Whether it is working with one or a number of FX liquidity providers, the relationship between them is key to its success.

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