By James Williams (pictured) – A wise man adapts himself to circumstances as water shapes itself to the vessel that contains it. (Chinese Proverb)
It’s a well-known fact that adversity breeds innovation. As tough as it has become to do business in today’s financial markets, there are always opportunities to evolve, to re-assess one’s priorities, to build strength through consolidation.
One particular segment of the industry in which this is being borne out is prime brokerage. Primes of all shapes and sizes face a new reality today: the need to become both operational and balance sheet-efficient, and to broaden out the product suite to help managers adapt and thrive in today’s regulatory miasma.
Last May, Newedge become a 100 per cent subsidiary of French bank Societe Generale. Already a well-established agency brokerage with a market leading reputation in clearing and execution services for CTAs and global macro strategies, having the full backing of an investment bank now offers Newedge – now Societe Generale Prime Services – the potential to ramp up its activity in equity-based strategies.
“We are speaking to a number of long/short equity managers running offshore, UCITS and onshore AIFs: we’ve brought on quite a few and our pipeline is strong,” says James Shekerdemian, Global Head of Prime Brokerage Sales at Newedge. “We’re putting a flag in the ground and saying ‘We’re here, we can service all your needs across the value chain of Prime Services’.”
One area that primes are having to focus all of their attentions is on balance sheet utilisation.
Balance sheet is a scarce resource everywhere and it always will be. As Shekerdemian points out, “It’s about how efficient you are at managing it”.
“We don’t have the pain of legacy. We feel we are in a strong position to support, build and help distribute products and provide a platform for clients. We’re not in this business for the short-term. We’ve got commitment from the bank and that’s vital. Alongside the strength of our offering, I think commitment is at the forefront of any client discussion these days.
“Clients need to know that their prime brokers are going to be there to provide a service,” adds Shekerdemian.
David Clarkson is EMEA Head of Prime Brokerage at JP Morgan. Rather than worry about the reduced levels of leverage that are set to impact the hedge fund space under Basel III, Clarkson takes a more sanguine view: “Basel III has the potential to further change the competitive landscape because banks now have an additional scarce resource to optimise. If a prime broker has a finite amount of balance sheet to deploy with client generated activity, it needs to be utilised in such a way as to maximise the long-term profitability of the business, whilst also recognising the increasing importance of non balance sheet-intensive client revenue opportunities,” says Clarkson.
This suggests that prime brokers will need to adapt their operating models and enhance their operating efficiency. That means taking a far more holistic view of the client relationship to ensure that the right services are being offered at the right price.
“Regulation is pushing banks to become more efficient around resource usage, and increasing the amount of netting or internationalisation is a key part of the process. Rather than simply taking in balances ad hoc across multiple strategies, to generate the best potential return you want balances that naturally complement each other. Longs covering shorts would be the most basic example.
“The relationship is getting a lot more scientific and this should strengthen as primes and hedge fund managers become more efficient financing partners. Managers will potentially become a lot more selective and concentrated in the counterparties they work with,” comments Ben Challice, Global Head of Prime Finance at Nomura.
Two years ago, senior management at Nomura decided that the right approach moving forward was to bring together its three existing businesses – a prime brokerage platform, a product-rich Delta 1 (synthetic equities) desk and a core equity financing business – into a fully integrated product-agnostic financing business.
The fruits of that integration were unveiled last April.
“We are product and asset class-agnostic when approaching clients and can offer cross-margining across various products. The ability to view the relationship holistically across not just asset classes but sub-asset classes and trading products is paramount. Under the leadership of Steve Ashley, two years ago we undertook a root and branch assessment of the equities and fixed income business and merged them into a unified Global Markets structure. Everybody sits on the same trading floor. This gives us full visibility on clients across products: from a return on financial resources perspective, it is first-class,” states Challice.
Nomura also has a centralised business resource management group to focus resources on where the best opportunities are.
“This helps us better identify which managers are good to partner with and which aren’t,” adds Challice.
Firms like Linear Investments Limited, which aren’t a part of global banking groups, are stepping in to the breach and servicing hedge funds of a greater size as tier one primes cut clients. This in itself is requiring a degree of adaptation because as CEO Paul Kelly points out: “If you want to engage with mid-size, larger clients you need to offer a level of protection that they are accustomed to. Pre- and post-trade controls are critical.”
Linear has made further investment in technology to better support cross-asset classes. Although this is achieved by working with multiple providers, clients only ever face off to Linear.
“We use multiple front-end providers that plug in to our hub. We have risk management in place to look across all the asset classes our clients trade; we have a back-end infrastructure to support all the sub-accounts. So although we back in to our providers with one omnibus account, all our clients have their own accounts,” explains Stephen McCreath, Head of Prime Services at Linear, confirming that Linear has had to build out a number of pre-trade risk systems.
“Before we send any client orders to execute we check that the client has sufficient funds, we look at their existing exposure on the market and if it passes all our system checks, only then do we release the order to the market. We’ve also replicated our prime brokers’ risk methodology with built-in buffers to further protect us as a firm,” says McCreath.
One area that Clarkson says JP Morgan is looking at is the convergence in corporate governance requirements of UCITS and AIFMD regulated funds. For example, both sets of regulation require the appointment of depositaries to undertake various fund oversight duties. This is proving beneficial to banks like JP Morgan who, as universal banks, can offer all the products a fund will need to meet their regulatory requirements, not just prime brokerage services.
“UCITS funds and AIFs require swaps, custody arrangements, fund administration and depositary services, whilst AIFs also need more traditional prime brokerage services. As a universal bank we offer all these services. To be successful in the new banking environment a firm needs to think holistically to bring all these services to the client. JP Morgan’s prime brokerage product sits within Investor Services which offers all these services,” comments Clarkson.
Over at Societe Generale Prime Services, through its alternatives-based research and reporting services, the focus has primarily been in global macro as opposed to single stock research. Now, as part of Societe Generale, it will be able to expand that offering further in the equities space and bring even more value to both managers and institutional investors with whom they have forged strong relationships.
“Those investors could be FoHFs, fund platforms, SWFs, family offices and so on. We need to know what investors want, not only to introduce them to managers but also to provide focused reports/white papers.
“Advisory, capital introduction and prime brokerage sales are the three pillars of our frontline discussion with clients,” says Shekerdemian.
In a similar vein to the opportunities that Clarkson sees with European regulation, so too Shekerdemian sees real opportunities for the business in the liquid alternatives space:
“We’ve seen a real growth in this space. For any prime broker, you need to be in a position to understand and help define the models that clients are asking for. I do think the liquid alternatives market is here to stay and am sure that it will form an ever important part of the world of Prime Brokerage.”
Throughout 2015, Linear’s McCreath says the firm will move to provide more comprehensive stock loan services and views it as area “where we see big opportunities”.
“We see ourselves as a smaller version of a tier one prime. We aim to mirror the services managers were getting there. As a result, we plan to add capital introduction services as well.
That said, emerging managers and start-ups will always be a key audience for us. When I was at Lehman, we took on a EUR12m fund and it grew to EUR3bn; we want to be in a position to see acorns become oak trees.”
Nomura’s Challice envisages more activity in the synthetic equities space.
“I also think we’ll see significant inflows into ETFs, both in Asia and Europe. The ability to offer custom baskets of securities as a combined product – alongside traditional clearing and custody and short selling abilities – coupled with an ability to cross-margin, is going to be an interesting opportunity moving forward.”
