Regulation, in the form of AIFMD and Basel III, has had a profound effect on the way that prime brokers and fund managers view their relationship. Ten years ago, things were simple. Hedge funds and prime brokers alike operated with fewer regulatory constraints, leverage financing was more freely offered to funds of all shapes and sizes. But the environment has become a lot more complex. Banks' balance sheets come under increased pressure and managers face direct regulation under AIFMD, requiring those running EU-based AIFs to appoint a depositary.
"Last year, one of the biggest impacts of AIFMD was that it directly changed how hedge funds ran their strategies and indirectly the relationship with their prime brokers regarding the operational set-up with depositary banks. This year, it is exactly the opposite. Basel III is directly affecting the way prime brokers do business with hedge funds and indirectly, how some fund managers have to run their strategies," says Gildas Le Treut (pictured), Global Head of Prime Services, ABN AMRO Clearing, Amsterdam.
Consequently, depending on their capital ratio constraints, prime brokers are becoming more selective with clients and prospects, sometimes even parting ways with funds that do not meet certain thresholds. Under Basel III capital requirements, banks have to closely look at how they allocate their financing capacities, how the funds' strategies affect the Bank's balance sheet and what is the overall return on equity of the clients. Certain hedge funds are being favoured when it comes to allocating balance sheet and extending a credit line.
Delphine Amzallag is European Head of Relationship Management, ABN AMRO Clearing Bank in London. She says that during the immediate post-crisis period, a number of larger prime brokers intensified their focus on top hedge funds as these moved to a multi prime relationship model.
"Not many could foresee the extent of regulatory pressures and financial burdens that would dominate. Now, however, these big market players are having to seriously rethink their strategy as balance sheet becomes more and more precious," comments Amzallag.
One problem, that some large universal banks are facing, is that they grew via client acquisition without structuring their organisation as a unique fully-fledged prime broker. They may combine a Prime Brokerage offering by using the services of different departments and even legal entities of the same group.
Services are managed out of various silos of the bank, even in different legal entities, making it difficult to have a holistic view of the profitability of the client and of the services. In such situations, it is often hard to speak as one voice to clients.
"Because of the new capital constraints, banks now have looked at the profitability of different product lines and made drastic changes such as stopping part of their offering. To run a trading strategy fund managers need cohesion of the service they receive from their Prime Broker," observes Le Treut, who continues: "Our cross-asset / cross-product clearing model allows us to have a holistic view of a client's strategy and portfolio, and precisely understand their risk and financing needs."
Of real importance, given the sensitivity of assessing the `worthiness' of a client, is the ability for prime brokers to get a complete overview of the fund strategy which might be profitable in one aspect, but not in another. Client retention is a key factor so the greater the insight a prime broker has, the better.
Due to its history in post trading, ABN AMRO Clearing can offer both Prime Brokerage and custody services, and in Amzallag's view, there are "big opportunities" to capitalise on the relationship between the two.
"In this regulatory environment, hedge funds and asset managers are very much focused on financing trading strategies and an asset protection mechanism. When you can combine the two, that offers efficiency and a unique selling point to managers," says Amzallag.
In this new regulatory landscape, the "one-size fits all" is not sustainable for Prime Brokers. Prime Brokers are becoming specialised in hedge funds strategies where they can demonstrate expertise in risk management, financing and deliver cost efficient services to allow funds to deliver performance. This is putting specialised prime brokers like ABN AMRO Clearing, who can offer cost-efficiency by providing execution and clearing and custody services, on a strong footing.
"I strongly believe that hedge funds not only look for specialised Prime Brokers that fully understand their strategies and can support their growth with the right level of financing. The same is valid for their depositary banks, that take on liability for restitution, to seek out financially sound and committed Prime Brokers," concludes Le Treut
