Hybrid Models and Liquidity Providers

The hybrid reality

Very few retail brokers are pure market makers or pure ECNs. A typical broker internalises small trades, hedges its net exposure when it grows past a limit, and routes some clients straight through. Whether you call that a hybrid, a market maker with hedging or an STP broker with a dealing desk is largely branding. What matters is that it is disclosed and that execution is monitored.

Who the liquidity providers are

• Tier-one banks such as JPMorgan, Citi, UBS and Deutsche Bank, which quote the largest brokers directly.
• Non-bank market makers such as XTX Markets and Jump Trading, which now supply a large share of retail liquidity.
• Prime brokers and prime-of-prime firms, which give smaller brokers access to bank liquidity they could not obtain on their own.
• Other brokers, which sometimes act as liquidity providers to smaller ones.

Why it matters to you

A broker with several strong providers can show the best price among them, which is why its spreads are tight and its fills reliable. A broker with one weak provider, or one that quotes only its own price, shows wider spreads and thinner liquidity at busy moments. Brokers that name their providers are more transparent than those that talk vaguely about deep liquidity, though naming them is not a guarantee of anything.

Questions to ask

Does the broker publish execution statistics? Does it name its liquidity providers or at least the number of them? Does it state when it internalises trades? Does the regulator require best execution? A broker with good answers to these is likely to give you good prices; one that avoids them may still be fine, but you are taking it on trust.

Key takeaways

• Most brokers are hybrids that internalise some trades and hedge others.
• Liquidity providers are the banks and market makers that quote brokers.
• The number and quality of providers shows up in your spreads and fills.