It has taken a global financial crisis – the worst in nearly a century – to shake up the prime brokerage industry, and even then, only by degree.
For all the dynamism of the hedge fund world it serves, prime brokerage has for the most part proved itself a staid business, in terms of who ranks where.
“It is trench warfare to change your market share by maybe half a percentage point,” says the head of one major prime brokerage business.
Others concur. “You have to earn it – that’s for sure,” says Teresa Heitsenrether, head of prime brokerage for the Emea region at JPMorgan.
The top table remains dominated by a handful of players. Depending on who you speak to this table has room for four, five or, at a stretch, six. But certainly no more.
And while there is certainly a group of up-and-coming entrants into the market, for the most part, their focus for growth is in niche areas.
Before the collapse of Lehman Brothers, two banks held sway: Goldman Sachs and Morgan Stanley were regarded as the undoubted reigning duo at the top end of the market, followed, not necessarily in order, by Deutsche Bank, Bear Stearns and Lehman Brothers.
Now, while few doubt that Goldman and Morgan Stanley remain towards the top, their undisputed dominance has vanished. Other players vying for precedence include Deutsche Bank, JPMorgan – which inherited Bear’s prime brokerage business – and Credit Suisse.
Depending on exactly where you are around the globe, or what your line of trading is, you may, as a hedge fund, have a different idea of who rules the roost..
The competition is tight.
Every bank; every prime broking executive; can provide different metrics as to why they trump rivals.
Goldman Sachs has seen its position relatively unchanged post crisis. Certainly, though, it faces a wealth of competition, its reputation and brand is still top of the pack, according to most hedge fund managers and even other rival prime brokerage executives.
“There is definitely a lustre about them,” says the head of one rival prime, on condition of anonymity. “When you get a startup choosing their brokers, they always tend to want to have Goldman as one of them.”
All of which is not to say others’ are weaker service providers, or smaller service providers, in actual terms.
Morgan Stanley remains a house praised for its “top quality” service and strong pedigree – having been at the top of the pile alongside Goldman for many years – but it has suffered relatively more by being perceived as a financially weaker institution, even if only incrementally.
Such concerns had begun to fade into the background until the last quarter of 2011, when the Greek crisis and the bankruptcy of MF Global caused a sudden rise in concerns over counterparty risk.
“We have really strengthened our business after a dip in 2008 and 2009,” says Alex Ehrlich, global head of prime brokerage for Morgan Stanley, nevertheless says. “Net net, 2011 was a strong year,” he adds, though the fourth quarter was certainly “challenging”.
Credit Suisse and Deutsche Bank meanwhile both contend for a huge amount of mandates in the post-2008 environment. Both enjoy the luxury of big, stable balance sheets – making them well-placed to provide more flexible financing terms, should they so desire, and to give clients more comfort in their own security.
Both also provide clients with serious, high-spec services as well.
Credit Suisse has picked up a string of high-profile mandates and has worked with almost all the largest startups in Europe in recent months. Deutsche Bank has meanwhile blazed a trail in areas such as Ucits funds.
For JP Morgan, the newest entrant, the past three years have also seen growth – though less evenly distributed.
The bank’s main impediment until recently was its almost sole – though undoubtedly strong – focus on the US market, a windfall gained in 2008 thanks to its acquisition of Bear Stearns.
JP Morgan is only now beginning to capitalise on its franchise. In 2011, the bank moved to launch a fully-fledged prime brokerage business in Europe – a move that will position it to compete on a more level playing field with other major players if it succeeds, but that has yet to begin bearing fruit.
And then there are the second tier firms – many of which still offer highly-competitive services to clients.
Citigroup’s prime brokerage, a relative newcomer having only been established in 2006, has grown steadily through the crisis and is, by most accounts, within striking distance of the top five players.
“Through 2008 we did exceptionally well,” says Nick Roe, Citi’s global head of prime finance. “The crisis projected us into the revolving top three at that point but unfortunately when people subsequently were concerned about Citi’s and the markets’ credit risk in 2009 we lost ground.
“We feel that within three years we can penetrate the top tier,” says Mr Roe.
Other large investment banks are pushing strong prime brokerage offerings in specific areas.
Barclays, for example, has concentrated on developing high-technology, ultra-fast trading capabilities for quantitative fund managers and fixed income traders. “In fixed income financing or repo we bid for top honours,” says Jack Inglis, managing director at Barclays prime services division.
Newedge, meanwhile – a joint venture between Société Générale and Credit Agricole – has focused on a specific hedge fund strategy, and is now one of the leading brokers for so-called commodity trading advisers thanks to its specialism in trading futures.
For all such apparent diversity, most prime brokers see the industry consolidating rather than changing radically in the year ahead, however.
There remains a tightly-knit, small universe of top funds – maybe 350 or so – that manage virtaully all the industry’s assets.
Most investors and market participants believe big hedge fund firms will continue – regardless of market conditions – to dominate, and while that remains the case, the struggle to service those few key players will naturally be intense.
In prime brokerage, to paraphrase Henry Kissinger’s quip about student politics, the competition is so vicious precisely because the stakes are so small.
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