Brokerages often focus on tighter spreads and better pricingwhen engaging a new liquidity provider (LP). However, liquidity agreementsrequire careful review. Several factors must be considered when entering orrenegotiating such agreements, whether with a Prime-of-Prime or Prime Broker.Segregation of AssetsFirms should determine if their assets are segregated fromthe LP’s own funds and those of other clients. If there is no segregation, thejurisdictional rules and risks involved must be assessed. In cases of omnibusaccounts, brokerages should consider the implications if another client in thepool becomes insolvent.Collateral ManagementCollateral, or margin, is cash or securities posted to anLP. Key considerations include whether the brokerage retains ownership,applicable discounts, and the timeframe for collateral delivery. Additionally,firms should assess whether they can reclaim excess collateral. Collateral transfers are often absolute, meaning the LPgains full ownership. This creates credit exposure, making the brokerage anunsecured creditor. LPs typically do not return collateral unless negotiated ata higher cost.https://t.co/MwO0xLqCor— Zurique Capital Research (@zuriquecapital) February 13, 2025Rehypothecation RisksLPs often reuse posted collateral for their own purposes,such as borrowing or lending. This practice reduces costs but increasescounterparty risk. Removing rehypothecation rights from agreements isdifficult, and brokerages should be aware that collateral may be used across anLP’s group entities.Events of Default (EODs)Firms should review default clauses, including whether theyapply to the LP. They should check if they can suspend payments, closetransactions, or set off amounts in case of an EOD. Additional terminationevents (ATEs), such as a decline in net asset value, should be reviewed oradjusted to avoid premature termination.While researching $HOOD this week I learned about an interesting revenue model called payment for order flow (PFOF)PFOF is an integral part of how brokerages like Robinhood offer commission-free trades. But there are some problems with it. 🔘 How Payment for Order Flow Works:… https://t.co/eOrO2eJygs— Gage The Fiscal Sage | Fundamentalist Investor (@FiscalSage) October 24, 2024Termination ConsequencesIn case of termination, brokerages must ensure alltransactions are closed out fairly. They should assess whether the LP canselectively close positions in its favor. The role of the calculation agent isalso crucial, as it determines termination amounts. Firms should considerappointing an independent agent if the LP is in breach.Additional Documentation ConsiderationsOther factors include the obligation for periodic duediligence, the rights of custodians over client assets, indemnities favoringthe LP, and tax provisions such as gross-up clauses. Dispute resolutionmechanisms and governing law should also be reviewed to ensure fair legalprotections.Brokerages must carefully examine these aspects beforefinalizing liquidity agreements to mitigate risks and safeguard their assets.This article was written by Sophie Gerber, Astrid raetze at www.financemagnates.com.