Someone raised a question on twitter the other day about the spate of new entrants to the prime brokerage space. (You can follow me on twitter by clicking here) Twitter is a great place for quick communication, but not so good for long answers. For what it’s worth, here’s my view. I’m interested in hearing from you if you disagree or if I’ve missed something important.
There are large number of firms that have announced new prime brokerage launches (HSBC, Nomura and Cantor Fitzgerald are amongst these); expanded product offerings (i.e. BTIG Fixed Income Prime Brokerage); changes to the structure of their businesses (MS launching a trust company); and expanded offices or increased staffing (too numerous to mention). The annual Global Custodian Prime Brokerage survey confirmed that there were more prime brokers that passed the minimum response threshold than ever before in their 16 years of running the survey. And that was before any of the recent launches.
There are many different reasons for these launches and expansions. While the hedge fund space has always been a profitable one for investment banks and dealers, until 2008 there was a virtual lock on the PB business. Morgan Stanley and Goldman Sachs were the dominant firms for global funds and in the US Bear Stearns was also a dominant provider. Other providers looked to satisfy specific product niches or to be appointed as “the other PB” alongside one of the triumvirate at the top.
Then the unthinkable happened and the Bear was eaten by JP Morgan. While that caused some concern, in and of itself it wasn’t enough to cause a major shift. The credit and liquidity crisis carried on and the markets continued to fall. Short selling restrictions and bans were imposed across some 30+ markets around the world. Lehman ran into trouble and wasn’t bailed out or bought. Panic ensued and there was a run on many firms including the two remaining PB market leaders. 2008 was a quiet uneventful year wasn’t it?
The result? Here are a few thoughts.
A more level playing field amongst the prime brokers than has ever been the case. The psychological barrier to entry of not being able to compete with the “big boys was reduced – even if the cost elements remained the same. This gave rise to opportunities for new entrants that could make a case for a niche product or be considered as a viable alternative to the mainstream providers.
Some PB’s chose to change margin levels, reduce the amount of leverage made available to clients across the board or on a fund-specific basis as well as increased pricing. Further, some PB’s changed their preferences for type of client, leading in some cases to relationship terminations. This is best exemplified by recent comments from UBS CEO Oswald Grubel: “we're aware it's balance-sheet intensive - and that's why we're becoming more selective on the clients we are offering prime brokerage". This highlights their change in strategy looking for fewer, larger and more profitable clients. According to Global Custodian hedge fund clients in the UBS PB business was once their fastest growing client base and this universe has shrank by a fifth! This is one example, but by no means the only firm that changed their approach. These fundamental remodeling of the business dynamics created a universe of disenfranchised or disenchanted clients ripe for the picking.
Hedge funds were suddenly made aware of existing risks involved with having a custodian of assets. They hunted for alternatives and found at least three: change of jurisdiction of the PB; switch to “safer” organisations, typically banks; diversification of assets across multiple PB providers. I am not convinced that all the firms that won business as safe “bolt-holes” will keep their new clients. Hedge fund service expectations aren’t the same as custody clients. Additionally, some hedgies have realised why they didn’t select certain PBs the first time around and may have regrets about actions taken in the heat of the post-Lehman environment.
In essence, many firms have seen an opportunity and have tried to jump on it. There will no doubt be further announcements of more firms joining the fray. The existing top tier of firms won’t give up their business lightly to the newer entrants and will use their muscle to squeeze the competition. Some of the newbies and niche providers will establish themselves as quality PBs, and this was demonstrated by the strong showing of Shoreline in the Global Custodian Survey. Inevitably some of the announced launches won’t actually come to fruition and will fade away. There is a history of firms trying to get into the space and quietly disappearing.
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There are large number of firms that have announced new prime brokerage launches (HSBC, Nomura and Cantor Fitzgerald are amongst these); expanded product offerings (i.e. BTIG Fixed Income Prime Brokerage); changes to the structure of their businesses (MS launching a trust company); and expanded offices or increased staffing (too numerous to mention). The annual Global Custodian Prime Brokerage survey confirmed that there were more prime brokers that passed the minimum response threshold than ever before in their 16 years of running the survey. And that was before any of the recent launches.
There are many different reasons for these launches and expansions. While the hedge fund space has always been a profitable one for investment banks and dealers, until 2008 there was a virtual lock on the PB business. Morgan Stanley and Goldman Sachs were the dominant firms for global funds and in the US Bear Stearns was also a dominant provider. Other providers looked to satisfy specific product niches or to be appointed as “the other PB” alongside one of the triumvirate at the top.
Then the unthinkable happened and the Bear was eaten by JP Morgan. While that caused some concern, in and of itself it wasn’t enough to cause a major shift. The credit and liquidity crisis carried on and the markets continued to fall. Short selling restrictions and bans were imposed across some 30+ markets around the world. Lehman ran into trouble and wasn’t bailed out or bought. Panic ensued and there was a run on many firms including the two remaining PB market leaders. 2008 was a quiet uneventful year wasn’t it?
The result? Here are a few thoughts.
A more level playing field amongst the prime brokers than has ever been the case. The psychological barrier to entry of not being able to compete with the “big boys was reduced – even if the cost elements remained the same. This gave rise to opportunities for new entrants that could make a case for a niche product or be considered as a viable alternative to the mainstream providers.
Some PB’s chose to change margin levels, reduce the amount of leverage made available to clients across the board or on a fund-specific basis as well as increased pricing. Further, some PB’s changed their preferences for type of client, leading in some cases to relationship terminations. This is best exemplified by recent comments from UBS CEO Oswald Grubel: “we're aware it's balance-sheet intensive - and that's why we're becoming more selective on the clients we are offering prime brokerage". This highlights their change in strategy looking for fewer, larger and more profitable clients. According to Global Custodian hedge fund clients in the UBS PB business was once their fastest growing client base and this universe has shrank by a fifth! This is one example, but by no means the only firm that changed their approach. These fundamental remodeling of the business dynamics created a universe of disenfranchised or disenchanted clients ripe for the picking.
Hedge funds were suddenly made aware of existing risks involved with having a custodian of assets. They hunted for alternatives and found at least three: change of jurisdiction of the PB; switch to “safer” organisations, typically banks; diversification of assets across multiple PB providers. I am not convinced that all the firms that won business as safe “bolt-holes” will keep their new clients. Hedge fund service expectations aren’t the same as custody clients. Additionally, some hedgies have realised why they didn’t select certain PBs the first time around and may have regrets about actions taken in the heat of the post-Lehman environment.
In essence, many firms have seen an opportunity and have tried to jump on it. There will no doubt be further announcements of more firms joining the fray. The existing top tier of firms won’t give up their business lightly to the newer entrants and will use their muscle to squeeze the competition. Some of the newbies and niche providers will establish themselves as quality PBs, and this was demonstrated by the strong showing of Shoreline in the Global Custodian Survey. Inevitably some of the announced launches won’t actually come to fruition and will fade away. There is a history of firms trying to get into the space and quietly disappearing.
To sum up, I think that even after the inevitable fallout of some also-rans, the universe of firms offering Prime Brokerage will be larger than it was a year ago. There will be better choice and a more interesting range of products for hedgies to choose from.
Now all we need is for the funds to continue the improved performance we have seen year-to-date and for investors to continue the green shoots of reinvestment into alternatives that have recently been sprouting …
