The last thing any hedge fund manager wants is to be off-boarded by a Prime Broker. It can be a destabilising and unsettling experience, potentially leading to a loss of confidence among investors. It is vital, therefore, to find the right Prime Broker that can partner with a manager based on a clear understanding of business wants and needs.
This is especially true in today’s regulatory environment where Basel III has caused banks to carefully consider their short-term and long-term liquidity positions and transform their businesses. In many ways, this has reshaped the Prime Brokerage relationship, making efficiencies and returns more important than simple revenue measures.
Stuart Bloomfield, European Head of Prime Services Sales, Scotiabank, recalls a time when revenue was the only industry metric, but adds that product expertise and funding efficiencies are now prioritised. Finding a bank focused on a particular piece of business is now more important when adding a Prime Broker.
“Prior to the financial crisis, most institutions had fewer constraints on the financial resources they deployed. Since then, regulation has helped to create a more level playing field. Financial institutions have become more attuned to maximising their returns on financial resources,” says Bloomfield.
New regulations have prompted Prime Brokers to reevaluate their hedge fund relationships and quantitatively understand exactly how much balance sheet and capital they consume. Those not meeting thresholds have been culled by some bulge-bracket Prime Brokers, as they chose to focus their efforts on the biggest clients or those with broadest product reach. A recent report by Quinlan & Associates attempted to quantify the impact of regulation. It estimated that the off-boarding of what it terms ‘tail clients’ has reduced revenue by USD13 billion among the top 15 global banks.
“Thinking about the survey results, the revenue among the historic bulge-bracket Prime Brokers has probably dropped, but so have the financial resources they allocate to the business line,” suggests Bloomfield.
“If you look at the returns on financial resources across those Prime Brokers, they’ve likely risen. Regulation has forced banks to be much more focused on return on capital.”
Some clients, and therefore revenues, might have been exited but the industry has seen the emergence of a number of mini primes that have taken up those tail clients.
Of course, one of the risks for traditional bank-owned Prime Brokers who cull hedge fund clients is that they do so without holistically understanding their economic footprint. Legacy technology and siloed businesses, where equities, rates and FX teams work independently, can make it hard for a Prime Broker to know the true value of a client. They might, in other words, be taking revenue off the table for no good reason.
This is providing an ideal platform for banks like Scotiabank, with its strong heritage of supporting clients in North America and Latin America. Bloomfield says that one of the key ingredients for building a strong relationship is for managers not to make assumptions about the competencies of an incumbent or potential Prime Broker. While Scotiabank is well known in North America, it is impressing existing and new clients with a strong product offering in Europe and Asia.
“More and more, people are focusing on specialist Prime Brokers and our strengths in Canada, Latin America and financial resources, whether it be our credit rating, or our Tier 1 capital ratio, which are very strong on a global comparison, have allowed us to disrupt incumbent Prime Brokers.
“Our global Prime Brokerage business continues to evolve and Europe, Asia, Latin America and the US continue to grow, complementing our Canadian business. We have a healthy pipeline of managers who have either joined us in the last couple of years or are in the process of doing so. While our primary purpose is to help North American managers in Europe and Asia, we are also focused on finding opportunities with local managers that fit well,” says London-based Bloomfield.
To that end, Scotiabank’s mission is a simple one: to target the world’s 300 largest hedge funds. Not to act as the sole Prime Broker, but to play a key role in a multi-prime relationship. The reason for focusing on the largest asset managers in the industry, says Bloomfield, is because “we want the relationship to provide various touch points to the bank and develop partnerships that can endure for a very long time”.
Just as fund managers need to think long and hard about whom they should appoint as their Prime Broker, likewise Scotiabank thinks very carefully about whether a client will be a good fit for the bank.
As Bloomfield intimates, most decent sized hedge funds will have more than one Prime Broker “so you need to find a mix of complimentary strengths. Managers don’t need three or four Prime Brokers, all of whom offer the same strengths. Rather there is a need to create a diverse pool of Prime Brokers who are strong in different areas; maybe one has expertise in capital introduction, one in fixed income, one is better at global equities and one has a strong sustainable story, with a strong credit rating and capital ratio.
“You need to understand your client’s strategy and be able to plan for the long term. Rarely do you finish where you start out. If we identify a global manager that has great potential to stretch across regions and other products in the bank, it would not be uncommon to start with a single piece of business and prove our worth before broadening the relationship.”
Scotiabank’s principal strength is to partner with equity-linked hedge fund strategies. One important development for its European business is the imminent launch of Direct Electronic Access, which Bloomfield says should go live in Q4: “Direct Electronic Access will unlock our capabilities to partner with systematic equity managers trading Europe, whether they’re located locally or from other regions.”
Today’s Prime Brokers have to pay more attention to each hedge fund client and enter into open and honest dialogue. As such, banks are looking to improve their technology stance to get a global and cross-markets view of attribution on a client-by-client basis. In Europe, some banks have taken a very inconsistent approach, making knee-jerk decisions to dial down their Prime Brokerage activities because of balance sheet constraints, only to then dial their activities back up, as more balance sheet becomes available.
This isn’t helpful to hedge funds that need to know they have a stable relationship where the rug isn’t going to be pulled from under their feet. This is something that Scotiabank is very mindful of.
“As a business, we’ve been able to demonstrate that our efficiencies and returns have improved as we’ve grown over the last few years. We will continue to remain thoughtful as to how we grow in future. Sustainability is key to what we do,” concludes Bloomfield.
