Question regarding "counterparty" brokers

Hello,

I have been looking to signup with an ECN to avoid dealing desks.

Can someone explain how a counter-party differs from a dealing desk.

As stated in the contract... (removed broker to avoid bias feedback)

"THE FOREIGN CURRENCY TRADING YOU ARE ENTERING INTO IS NOT CONDUCTED ON AN EXCHANGE. BROKER IS ACTING AS A COUTNERPARTY IN THESE TRANSACTIONS AND, THEREFORE, ACTS AS THE BUYER WHEN YOU SELL AND THE SELLER WHEN YOU BUY. THE PRICES BROKER OFFERS MIGHT NOT BE THE BEST PRICES AVAILABLE.

ALTHOUGH BROKER IS THE COUNTERPARTY TO EACH OF YOUR TRADES, BROKER LIMITS RISK TO ITSELF BY INSTANTANEOUSLY OFFSETTING THE TRADES AND POSITIONS IT ENTERS INTO WITH YOU WITH A BANK OR INSTITUTIONAL MARKET MAKER. AS A RESULT, BROKER DOES NOT PROFIT WHEN YOU LOSE MONEY ON A TRADE. RATHER, BROKER EARNS COMMISSIONS ON EACH TRADE IT ENTERS INTO WITH YOU."

How does this differ form a dealing desk? This said broker claims no dealing desk.

What risks to the broker are being limited? Maybe I am not understanding the concept of a counter-party.

Thank You

Hi,

Brokers with dealing desk are usually the counter parties and they take the other side of the trade and fill it up for you without processing your order on the FOREX market usually.

ECN brokers are no different except that they are not the counter parties, they just provide you access to the FOREX market and you trade against other individuals or banks which are in this situation the counter parties.

Personally I think the difference is that the dealing desk brokers profit from the spread so the spreads you'll get are larger than the ones ECN provides usually because they profit from a fixed commission per trade, and by that they can provide the lowest spreads available in the market.

If I didn't answer your questions I'll be glad to help you out more.

Have a good day.

A dealing desk just takes the other side of all your trades, so they win when you lose, and lose when you win. What they are saying above is they pass on this exposure to the interbank market; as soon as they do that, they are no longer on the other side of the trade, and have no position in the market.

Although they have to disclose they are the counterparty at the instant the trade is executed, they only stay the counterparty for a micro second.

They limit risk in that by offsetting the trade to an outside bank, they no longer have any risk that the market will move against their position (because they have no position). A dealing does have a position; it's the opposite of YOUR position...

The issue of counterparty comes up in bankruptcy, fraud or trade disputes.

When FX company, say ForexScumDealer takes your order and then offsets it in the "interbank market", they then owe say JP Morgan on their trades or vice versa.

JPM allows ForexScumDealer to trade with them because they have passed some kind of credit check---or ForexScumDealer has an account with Goldman and they know Goldman has the gold.

JPM won't trade with Joe Six Pack directly because they are afraid J6P won't pay.

meaning of counterparty:

On a regulated exchange, say NYSE or the CME, when you make a trade, the exchange is the counterparty legally to all transactions. Imagine you sold some security from somebody who bought theirs through Lehman Brothers and before settlement Lehman went bankrupt. (This was a real situation, not hypothetical!)

In that case you are obviously owed money and you get the money at settlement. On an exchange-listed security, when LEH goes to 0.0000 and refuses to pay cash to settle, then the NYSE or CME has to pay out the money on its own account.

On an OTC market (like spot FX), you're screwed. You become an unsecured creditor in bankruptcy court.

Difference between ECN and exchange:

ECN will aggregate orders and show best bid and ask, like an exchange, and communicate to the clients. But it is not formally the financial counterparty. So an ECN is a technology company or technology service.

It would be much better if there were a true regulated exchange for spot FX with the same liquidity. There are currency futures (different numerically because of swap/settlement) on CME but there is much less depth and pairs available.