There are two risk management assertions that every brokerage business needs to address related to each business’s risk model.
A-Book brokers are business models that act as intermediaries between traders and interbank markets, and their profit margins are allocated through commissions and markups. Thus brokers using the A-Book model don’t carry any risks and become profitable as long as traders generate revenue. In addition, it allows brokers to start a Forex business with a lower licensing budget.
B-Book brokers act as liquidity providers and every trade that takes place on the broker’s platform, with the broker bearing the responsibility of the user’s finances. As a result, brokers operating a B-Book risk model have a lower trust standard yet still require a high sum for obtaining an operating license.
On the other hand, in the hybrid model, brokers can appoint how each trade gets executed and on which model. However, liquidity providers that obtain toxic trades can degrade the execution of the trade, which leads to increased slippages leading to a less than ideal experience for traders. However, brokers can develop instruments to address the unequal distribution of trades.
Regardless of its risk model, every brokerage business has to address three main risks.
Issues with liquidity providers
Brokers have to address the imbalance in the relationship between liquidity providers and brokers. Liquidity providers can increase traders’ spread which ultimately erodes traders’ trust. In addition, complete dependency on one liquidity provider will lead to possible issues for the broker when the provider incurs financial or technological problems. As a result, brokers should use more than two liquidity providers to back users’ assets and mitigate any occurring risks.
Problems with a technology provider
Maintaining and funding the backend of the brokerage business can be costly. Therefore, brokers prefer contractors and service providers because they decrease management and development costs. However, every new development and fix make broker business be dependent on a single entity which could lead to more platform issues if not executed correctly.
As a result, brokers should review every promise made by the sales manager and pre-test any new implementation before setting it live.
Untimely hedging of client’s profits
Traders seek brokers because they can facilitate trading activities; however, when large market fluctuations occur, brokers should be covered and not impact users’ funds. The best way to handle users’ funds is to implement a less risky model that does not affect users’ trading activity and also keeps track of trading behaviors to prevent further financial losses. The best way to approach a broker business is to implement a hybrid model because it allows more flexibility and minimizes the financial impact.
Soft-FXsoftware solutions can offer risk management instruments for brokerage businesses.
