New trends – from technology and data to digital assets and ESG – are transforming the way hedge fund firms invest and operate. What new innovations, products and services are prime brokers offering to keep pace with this evolution?
New trends – from technology and data to digital assets and ESG – are transforming the way hedge fund firms invest and operate. What new innovations, products and services are prime brokers offering to keep pace with this evolution?
With markets in a continuous state of flux, new products coming into play, and new regulations being implemented, the need for prime brokerage businesses of all shapes and sizes to constantly evolve is key to maintaining an edge.
For prime brokers servicing systematic hedge funds, for instance, whose businesses centre around fast-moving computer-based investment strategies, this means building out new or enhancing existing technology or making other changes to the platform or processes to service such clients.
For newer asset classes – such as cryptocurrencies – it may entail a more far-reaching and challenging expansion. Elsewhere, as responsible investing and environmental, social and governance (ESG) metrics have garnered interest among allocators and managers in recent years, prime brokers are also taking active steps to tap into the momentum for sustainability-focused products.
The ways in which prime brokers can best capitalise on these assorted trends amid the relentless drive for innovation that underpins much of the hedge fund industry will help define the sector in the coming years, industry participants say.
With technology becoming more important for hedge fund strategies of all stripes, and quantitative managers in particular trading ever-larger amounts of activity, a prime broker’s ability to handle such demands from an electronic trading perspective is critical.
“If you take technology in an investment bank, the number one priority today is architecture – pure tech spending to reduce the unit cost and to be able to innovate on the functionality faster. It’s the same in asset management,” says Stephane Marchand, head of international prime finance and clearing sales at JPMorgan in London.
Most quantitative hedge funds have their own in-house technology and quant teams developing their trading models, and these firms are looking for their prime brokers to have the infrastructure to service the fund’s trading activity.
“That infrastructure comprises three key areas for a prime broker: operational, technology and financial resources,” says Eamon McCooey, head of prime services at Wells Fargo.
“A prime broker needs to have reliable and efficient operational and technology capabilities to provide capacity and scalability to meet our client needs across all market scenarios. It is critical that processing occurs in an automated and straight through environment to provide scalability and reduce operational risk. Coupled with a strong balance sheet and appropriate financial resources allows these funds to execute their strategies in a seamless manner.”
He continues: “Given that Wells Fargo is relatively new in the prime brokerage space – we launched our business in 2014 – we were able to take advantage of a lot of the new technology that was available during our build-out period. We made significant investments across the business including in our low latency trading.
“We were able to partner with a market leader to provide scalability and throughput capacity with regards to the processing of those transactions. In addition, we invested in our post-trade processing capabilities including operation settlements, corporate actions tools, enhanced reporting, client portal with self-service tools for reporting, payments, corporate actions, security lending locates and other services which are important in servicing our customer accounts.”
Bespoke
Mike Ginelli, managing director and global product head of prime brokerage at CIBC Capital Markets, pinpoints cryptocurrency and quantitative strategies as two key trends currently underpinning PBs’ business evolution.
“From a cryptocurrency perspective, we are actively financing both US and CAD exchange traded products that reference digital assets. From a quantitative perspective, we continue to leverage our dominant market share by volume on the TSX, where we can provide unparalleled Canadian execution for these managers,” Ginelli says.
“In addition, we are well positioned to provide bespoke margining specifically designed for quants. Both of these areas are very important for the future of CIBC Prime Brokerage and building out these capabilities from a personnel and tech perspective remains a high priority. As such, we continue to make significant investments in the areas of locates processing and axe lists.”
The increasingly quant-focused nature of the business has also come into sharp focus during the staffing process, notes Ashley Wilson, global head of prime services at BNP Paribas in London.
“In the front office, I like to hire people with a quantitative skillset, specifically in the execution side,” he says. “That flows over into wanting quants in my client analytics, and quants in risk.”
He adds: “We now have a global business with an execution capability that can handle the most complicated of quant funds, which are obviously continuing to grow. With the bolt-on Exane acquisition, which gave us the European algorithms that Exane had, plus Exane’s research, which is highly-ranked in Europe, that is an attractor that funds like to have access to.”
This increased emphasis on quantitative capability within primes is, in turn, shaping their approach to hiring.
“We have a programme to hire quants, which runs parallel to the grad recruitment process. I want to hire quants from specific universities that we’ve identified, and have this deep math skill right across the board – that’s where we are expanding,” Wilson says.
Elsewhere, as cryptocurrencies, digital assets and blockchain technology become increasingly visible and viable components of the financial services universe, investment managers such as hedge funds – never shy of seizing on emerging trends and sectors and pioneering new strategies – require trading, clearing, settlement and custody of digital assets.
As such, prime brokers now need to offer a technology-driven dedicated solution, according to George Zarya, founder and CEO at Bequant, a Malta-based regulated virtual financial assets prime broker which services institutional and professional traders.
This includes lending and borrowing services, access to trading venues, cross-margining capabilities, and post-trade services, among other things.
“An agile, holistic, cross-integrated platform should allow the client to automate the whole cycle without being reliant on an army of operations people. This is all about technology,” Zarya told Hedgeweek recently.
Noting how Cowen has been among the early movers in the SPACs space, as well as in cannabis stocks and cryptocurrencies, Chris Elliott, head of European prime brokerage at Cowen, says: “We continue to evolve and innovate in keeping with the entrepreneurial spirit that you would expect from a boutique quick moving investment bank.”
Jack Seibald, managing director and global co head of prime brokerage and outsourced trading at Cowen adds: “One area in the US where we do have the ability to touch much larger entities is in specialty asset classes – cannabis stocks being a major example.
“We are the only US-based prime broker offering a cannabis solution that ranges from execution to custody and clearance. That’s a major differentiating capability relative to the big bulge bracket firms.
“It means that we’ve served as the prime broker to most cannabis-dedicated hedge funds over the past few years, and more recently we have become the prime broker to some very large hedge fund platforms that have carved out a portion of their book to allocate to the cannabis space.”
Seibald says the ramp-up in Cowen’s outsourced trading business, which has seen it add fixed income and FX products in recent years, has also taken it towards “a different tier or calibre” of client, such as those typical of larger, bulge bracket outfits.
He explains: “We’re doing the outsourced trading for those larger funds, and when they move towards an incremental prime solution – whether it’s for a specific need or whether it’s just to diversify – we are increasingly there in the mix because we do have the capabilities to service them in much the same way as the bulge brackets do.”
Transition
In a number of instances in recent years, Cowen has transitioned some of its outsourced trading relationships into at least partial prime brokerage relationships, Seibald adds.
“Outsourced trading for us as a firm has been a game-changer over the last decade,” he observes.
“It’s a value-added service that has become increasingly appealing to a much broader audience within the investment management community. It used to be very centered on hedge funds – smaller to mid-sized hedge funds – but it’s now taken on a life of its own to the point where very large hedge funds and, more importantly, the traditional investment management organisations – like family offices, endowments and foundations, and even large investment advisory firms – are either looking at or have taken on that service, for a variety of reasons. One is cost, the other is expertise. That’s relatively difficult to replicate unless you dedicate an enormous amount of resources to it.”
Pointing to the substantial drive towards ESG within the industry, Will Davies, managing director and head of UK sales, prime services at Société Générale in London says: “We have an enormous initiative and push towards ESG across every single facet of the bank, with the prime services being very much part of that drive.”
The challenge with ESG, however, remains in determining industry standards and taxonomy, and the metrics that go with that, in terms of how ESG is measured, and how success is measured.
“We are working with exchanges on the futures side to push ESG and be at the very forefront of the ESG phenomenon. If you look at it from our perspective as a PB, what we can do is that we have added an ESG future algo to our algo suite; we have held surveys and various webinars with ESG-focused clients. At every juncture we try to be as relevant as possible for clients and investors alike.”
Read the full Charting New Territory: The future of hedge fund prime brokerage Insight Report here.
