Forex OTC market differs from investing in many other financial instruments like for example equities or futures trading because it is possible for the brokerage houses to take the other side of customers’ trades (so trade against them)
This is where the distinction between the A and B-Book brokers comes in together with many hybrid-combinations in between.
The A-Book model
Brokers operating in this model are regarded as ECN/STP (Electronic-Communication-Network/ Straight-Through-Processing) brokers also known as “No Dealing Desk” brokerages. Such brokers are intermediaries that send all of their clients’ trades directly to liquidity providers or multilateral trading facilities.
These forex brokers make the profit by increasing the spread or by charging their customers commissions. In this situation, no conflict of interest does exist because brokerages earn the same amount of money regardless of whether the trader is profitable or not.
The B-Book model
B-Book brokers, on the other hand, keep their clients’ orders internally. A brokerage house, in this case, takes the other side of a trade therefore its profits very often equal to clients’ losses and the other way around. Due to the fact that the great majority of clients lose money in a long-distance run, keeping trades on their own books can be very profitable (if the trading flow stays within Client- Retail broker scope only with no trades send to LPs it is considered as B-book (see image below).Since there is an obvious conflict of interest many clients are afraid that brokers may use unfair practices to ensure they remain profitable.
Nevertheless, this model is considered as a very risky and challenging in terms of risk management.
This is the reason why many market maker forex brokers use a hybrid model that involves hedging with liquidity providers as well as placing trades in a B-Book based on traders’ profiles.
The Hybrid model
The popularity of the hybrid model is justified as it allows brokerages to take advantage of the two above-mentioned models. The entire tactic rests upon identifying chosen group of traders who are profitable and send their trades to the real market, while keeping the remaining part in-house.
Clients who are likely to be kept on the book have usually few common characteristics.
First of all they are keen on significant leverage, use their free margin to the very extent as well as deposit lower amounts of money of their trading accounts (statistics clearly show that lower deposit accounts are overall less successful).
Many brokerages operate in a hybrid model, and there is nothing inherently bad in such a model. This model runs very responsibly and with appropriate attitude toward risk-management can be very successful.
While benefiting from both types of models such brokerage houses can offer their clients competitive markups and commissions whereas the hybrid model is also better perceived by clients.