Ecn/Stp vs Market Maker Brokerage Model

June 10, 2023
Ecn/Stp vs Market Maker Brokerage Model

The brokerage industry offers two primary models: ECN/STP and Market Maker. The ECN (Electronic Communication Network) model signifies that the broker is connected to an e-trading system where competitive bids and offers are consolidated. STP (Straight-Through-Processing) indicates that the broker does not intervene in order execution, ensuring all transafers are processed electronically with utmost speed. It’s worth noting that a Market Maker (MM) broker can also fall under the ECN/STP category if order execution is conducted using specialized software rather than manual intervention by a dealer.

In the Forex trading community, A-book brokers are widely recognized as brokers who directly send orders to one or more liquidity suppliers. This term encompasses both the ECN and STP models mentioned earlier. The primary advantage of this model lies in the fact that the broker does not bear the risk of client trading and generates revenue from trade turnover. Hence, it is beneficial for brokers when clients avoid losses and engage in more trading activities. Consequently, traders perceive these brokers as more reliable and profitable.

Furthermore, this approach offers the benefits of lower licensing costs and simplified regulation. In recent times, traders have increasingly preferred brokers regulated in specific jurisdictions, resulting in a decline in unregulated offshore companies’ clientele and trust.

On the other hand, Market Makers, unlike ECN/STP brokers, do not cover positions with liquidity suppliers. They are obligated to compensate for customers’ profitable trades using their own funds, making their earnings dependent on clients’ losses. They are commonly referred to as B-book brokers. Although this model entails greater risk, statistics indicate that the majority of customers tend to lose money, resulting in higher revenues for MM-brokers compared to ECN/STP brokers with similar trade volumes. Opting for the Market Maker model may require additional risk administration solutions to monitor platform abuses and take preventive actions. This translates to increased expenses on dealing and specialized software.

However, it’s important to consider that acquiring an MM broker license in a recognized non-offshore jurisdiction necessitates a substantial security deposit, ranging from 100,000 to 1 million units of currency, depending on the jurisdiction. Additionally, regulatory reporting obligations incur their own costs. Nevertheless, technology can streamline this process. For example, our company already offers a answer for submitting reports to the Japanese Financial Services Agency (JFSA), one of the strictest financial regulators. By understanding the requirements of various regulators, we can develop similar solutions for other jurisdictions.

It’s also worth mentioning that some offshore locations do not offer Forex licensing at all. Consequently, some brokers establish an MM company in an offshore jurisdiction while opening another company with an ECN/STP license in a regulated jurisdiction to gain customer trust. In this setup, the offshore MM company acts as a liquidity supplier, allowing the broker to display a license from a reputable regulator while essentially operating as an offshore Market Maker with minimal costs.

Many brokers combine these models by selectively routing some customer orders for A-book execution and processing the remaining orders using the B-book scheme. The implementation of this scheme may vary: some brokers independently decide which orders are passed to the liquidity pool, transparently hidden from the client, while others offer separate ECN/STP accounts guaranteeing order transmission to the interbank market.

To summarize, let’s highlight the main points regarding the two primary brokerage models:

  • Traders generally place more trust in the STP structure, although some Market Makers employ tactics to position themselves as STP brokers.
  • A-bookers find it easier to register their company under a reputable jurisdiction.
  • STP brokers are not exposed to risks associated with scalping strategies.
  • B-book brokers generate revenue from client losses, in contrast to commissions and markups earned by A-book brokers.
  • Typically, Market Makers tend to earn more than STP/ECN brokers.
  • The choice of which model to adopt depends on the target audience a broker aims to attract. This decision leads to a clearer understanding of the desired jurisdiction and model, as well as the associated risks and costs.

In conclusion, brokers have the option to operate under the ECN/STP or Market Maker brokerage models. While the ECN/STP structure is favored by traders due to its perceived clarity and lower risks, Market Makers can position themselves as STP brokers through certain strategies. Brokers may also consider the jurisdiction in which they wish to establish their operations, as it affects licensing requirements and customer trust. Ultimately, the decision between the two models should align with the broker’s target listeners and be accompanied by a comprehensive understanding of the risks and costs involved.

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