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FX: Do you understand what we do?

Content, content, content. In a bid to flesh out our swelling blog and case-study portfolio I asked the team "What can we blog about next?". They were no help at all and threw out

topics like "what bank accounts help the international business man..." and "5 ways to keep ahead of interest rate rises". So, I have turned domestic and think it both relevant and generous, on behalf of the Prime Cap team and the wider deliverable FX community, to do that which many of our peers take for granted and explain what we do and why it is useful.

This won't be Prime Cap talking about what Prime Cap does well - for that you can give us a call. This is an attempt to outline why it is silly, pure and simple, to use a less competitive method of sending or receiving money, and an attempt to explain the actual ways in which we do what we do, how we make money doing it and why it is here to stay.

First off, 'foreign exchange'. I'm told that even this expression could do with some clarification. Foreign exchange and its various abbreviations and acronyms (Forex & FX) is simply the general financial term for the exchanging of one currency for another. Nothing more, nothing less. Foreign exchange services are the ways and helpful forms of assistance, whether via human guidance or online systems, that you can exchange one currency for another.

It may seem odd, but, when you electronically transmit your pounds sterling to a euro account, you are in effect exchanging the currency you hold for the currency you want in quite a literal sense. Sterling does not just turn into the other currency because it enters the bank account of the other currency. An actual contract is struck and a transaction takes place. The pounds you used to own/hold always remain as pounds and, in fact, never leave the UK. They are simply substituted for euros from within the country you're sending the money and then reflected in your euro bank account. The same is true of US dollars. None actually physically leave the United States...they are simply digitally reflected as the currency you've bought in the account denominated in that currency, wherever that is geographically.

Now, I mentioned that you are essentially 'exchanging' the currency you have for the currency you want. You are striking an agreement with whomever you're exchanging your pounds with. Unfortunately for you, Mr I.N. Dividual, there are very very few people with whom you can legitimately exchange your pounds. Furthermore, the financial system is set up so that for individuals like you the 'buyer' of the currency you hold, the institution or company you're exchanging with, is essentially in complete control over what amount of euros they're prepared to give you for the pound you hold.

You are, in relative terms, exchanging such a small amount of money (in the context of the foreign exchange markets where banks might be exchanging billions of GBP a day) that you basically don't get any say in what price you can command for it. This is a shame, but, it is the nature of the system and it does stand to reason that the entity with the largest amount of something tends to call the shots on what they will charge you for it.

All this pre-amble boils down to the fact that not every bank exchanges currency at the same rate or with the same type of customer. I mentioned before about the fact that you are exchanging a small amount of money when compared with the overall amount transacted daily across the financial world, well, by going to someone (an institution, a business or even an individual in some cases) who exchanges more than you, you may be able to piggy back off the improved rate they get from the person they exchange money with. It is kind like a tiered system where the higher up the tiers and the larger the volume and the more regular the transactions, the better the terms. You, Mr I.N. Dividual, can piggy back onto my rate and, provided I want to, can receive the rate that I get.

If you were transacting many millions, if not billions, of pounds worth of currency then you're bank would give you the same rate they give me.

I am still doing exactly the same thing as you. I am essentially logging in to my online banking and asking my bank what rate of exchange they will give me for the £1 I want to transmit, but, that £1 is in fact £10,000 and I have 1000 clients who want to exchange £10,000 on any given day. Mr Bank is going to give me a nicer rate because he doesn't want me going up the road to his competitor. It is cheaper for him to sell me euros and for me to then deal with my 1000 clients than it is for Mr Bank to actually tailor the way he works toward dealing with those 1000 himself. He is effectively selling me what I want at a wholesale rate. I then pass it on to you...if I am a scrupulous better than retail. You can get retail from Mr Bank, so, all I have to do is make sure my margin is less than his.

Now, if I gave you the same rate of exchange that I receive from Mr Bank then, in essence,

you're doing much better than you would dealing with Mr Bank yourself, however, I, on the other hand, am receiving a lot of sterling and exchanging it for a lot of euros, but, unless I charge you something, the same money coming in is the same money as is going out, only it is now denominated in euros. In some ways this is the most common misconception and confusing aspect of the role of a broker like me - how do I make any money out of giving you the euros the bank has sold me, and, what is a reasonable charge for the rate/benefit I am giving you?

I make money from the fact that I receive 000s of pounds and send out 000s of euros thus: I shave a small percentage off the amount of euros I give you for your £1.

By way of example. You send me the £1 you want to exchange. Mr Bank has told you he will give you €1.10 for it. Mr Bank tells me that because of my strong and longstanding relationship with him he will give me €1.20 for the £1 I want to exchange with him. As said before, were I to give you that €1.20 then at the end of the day there would be nothing left in my account...what has come in has gone out. So, I offer you €1.15 in exchange for your £1.

You are therefore receiving €0.05 more because you are allowing me to exchange your £1 with Mr Bank. I am also making €0.05 for my services.

If we scale up that example to £10,000 for you, then rather than the €11,000 your bank has offered you, I am offering you €11,500. I am keeping €500 for myself and we both go our separate ways, happy in the knowledge that we have both done equally as well out of the exchange as the other.

In principle this is the way the deliverable foreign exchange sector works. 'Deliverable' meaning you, or the foreign currency bank account you want your euros paid to, is actually taking physical receipt of the currency; I am buying and delivering it for you.

One thing to note - in the modern financial world and, given the regulations on financial transactions and sending money, one needs to physically collect or receive all of those £1s in order to exchange them with the Bank. Companies like Prime Cap and Ebury Partners (one of our partners) cannot feasibly set up individual bank accounts for every single one of our clients to send their £1 to; this would be madness and near impossible to achieve. So, our industry regulator the 'Financial Conduct Authority' (FCA) allows foreign exchange businesses to collect all these £1s into one account. Every clients' money in one account. Some clients do find this unnerving. What happens if my money gets mis-labelled? What happens if an unscrupulous employee accesses this one account and sends it's contents somewhere they shouldn't? What happens if the company runs up debts it cannot pay - does the money they hold for me get used to pay?

Well, the regulations are very strict. The banks we use to hold these type of collection bank accounts - known as 'Segregated Client Trust' accounts - are subject to regular audit. Any company itself must have sufficient amounts of its own money to be able to cover the appropriate proportion of its liabilities at any one time. This means that no businesses complying with the FCA rules should have less money of their own, not yours, than is necessary to satisfy debtors - you may have heard of this referred to as capital adequacy/reserves in the context of high street bank after the financial crash.

To that end, these 'collection' accounts (my term, not a commonly used one) are 'segregated' from the company's books and management accounts. Although your £1 is sat in an account along with the £1s of all my other clients, it is not mingled with my company money at all. The segregated account is in my name, not yours...but, this is simply because Mr Bank is selling me all those €s and not my clients individually.

When you register to become my client I simultaneously create a profile and a footprint for you on my FCA approved Client Relationship Management system (CRM). These profiles/signature are indelibly linked to any money I receive for you; hence, were I'm hit by a bus and the list of whose money is whose goes missing, my bank and my own company internal systems (which have to be compliant and accessible in themselves too) will tell the regulator what money I am holding and who it belongs to; it is then returned.

I recently heard a story about a tour manager for a band who, despite sending payments all over the world on a regular basis, resolutely refuses to use a 'broker' like Prime Cap for his payments even though he knows Prime Cap and our ilk can save him some money. He prefers to work with his bank. Prime Cap's approach is not to dismiss his preference. Of course we'd remain resolute and confident that we could ensure some money was left in his account because of our rates, but, we take a slightly less serious view when it comes to pursuing new business. By that I mean that if you are in the business of sending money, the paradigm is not 'bank vs. non-bank'. Foreign exchange companies are basically just a different provider of a foreign currency. The sector is regulated in much the same way as the banking sector when it comes to holding client money, money laundering and 'know your client' and, over time, what we do will only become more and more main stream. This will undoubtedly prompt banks to try and compete, of course, but, for now there are enough of the tour managers around that the bank isn't pushed to lower their prices. Plus, they're selling to businesses like us anyway so just shifting their model to a wholesale one rather than retail.

It is worth mentioning that Prime Cap's 'collection' accounts (I'm unsure whether that term deserves to stick or not) are held with a wholesale corporate FX company called Ebury Partners. Ebury turnover a couple of billion pounds a year, so they are firmly in the top tier (aka Tier 1) of the corporate FX houses. Our work with the private client sector is something they envy (we tell ourselves), but, in essence, using their collection accounts helps Prime Cap stay on top of regulatory changes and improvements to the way a payment gets to its destination. In essence, you do not send your £1 to Prime Cap's segregated accounts. Instead you send them to those of Ebury. They are the custodian of our settlements. They are also the institution we buy a lot of our currency from, so we know we are getting the benefit of the colossal amounts they trade at a wholesale level and we simply mark that up a fraction when pricing for you.

If you'd like us to explain more about that set up, and it would be our pleasure so to do, then give us a ring on 02031728193.

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