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Filling the void

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As banks like JP Morgan pull the plug on supporting ‘mini prime’ clients, introducing brokers that operate a multi-clearing service model look set to benefit.

The decision three months ago by JP Morgan’s prime brokerage business to cut lose its clearing and financing arrangements to hedge funds working with introducing brokers (‘IBs’) could have serious repercussions.

Introducing brokers that have only one or two clearing arrangements in place face uncertain times, not to mention emerging managers who rely on IBs as an essential middleman to provide crucial services. This is because they lack the size to warrant a tier-one prime brokerage relationship with the Morgan Stanley’s and Goldman Sachs’ of this world. 

The fear is that managers may be disrupted as they look for other solutions, either through their current IB or another. It is also a concern that they may face potentially higher costs as alternatives are limited following the JP Morgan exit. 

Concept Capital Markets LLC runs a multi-clearing introducing brokerage model. Prior to the JP Morgan decision it had five clearing agreements in place: the others include Pershing, Merrill Lynch, Merrill Lynch Professional and ICBC, a major Chinese banking group.

As a consequence, Concept Capital has been able to absorb the impact with minimal disruption to its clients, fully justifying its decision to establish what is a more operationally complex model, yet one that is better able to respond as bank-owned primes weigh up their future. 

“While our clients were dismayed upon hearing of JP Morgan’s decision, they were satisfied with the alternative solutions we could offer and the speed with which we could arrange for the transfer of assets. The one question we got asked, more than any other during the process, was ‘Who do you suppose will be next to follow JP Morgan?’” says Jack Seibald (pictured), managing member at Concept Capital.

“We’re not in a position to know, but one of the things we were able to articulate well to our clients was the difference between the types of banks or institutions that our clearing firms belong to, and the relative importance of the clearing and custody business to our respective banks. I think that helped add a bit of colour to the discussion and helped our clients arrive at the best decision.”

One of the decisions that Concept Capital made was that whatever existing pricing agreements were in place with clients with accounts at JP Morgan, they would uphold them as they moved to one of the other four banks. As Seibald adds,  “we made it clear to our clients that we would honour our commitment to them and that it would be our responsibility to negotiate with the other clearing firms as necessary.” 

That ability to react quickly has no doubt been appreciated by Concept Capital’s clients. Its systems are fully integrated to each of the other four banks, which meant that transferring each client’s book of business was relatively straightforward.

The majority of client accounts have been transferred to Pershing and another meaningingful number to Merrill Lynch, says Seibald, both of which are long-standing relationships. The Pershing relationship has been in place for 18 years, whilst the Merrill arrangement has been in place for four years. 

“We reached out to all of our clearing firms, but those two in particular were very receptive, willing, and capable of discussing our client business at J. P. Morgan and what would make sense for their books. By focusing on an expeditious solution, as opposed to thinking about how long we could stretch the arrangement out at JP Morgan, it allowed us to get ahead of the other IBs when it came to transferring our clients’ assets. 

“Pershing allowed us to do a ‘tape-to-tape’ transfer, whereby the entire history of each account moved to their book by electronic transfer. It worked pretty well. We completed that in mid May,” confirms Seibald.

Asked whether this justified Concept Capital’s decision, day one, to operate a multi-clearing IB model, Seibald clearly believes it did. He recalls that both clients and internal operations staff questioned the need for so many clearing solutions, noting that such arrangements create a lot more work as the systems used at banks tend to be independent of each other and the manner in which they report on portfolio activity is different. That creates more work at the back-end for Concept Capital when it comes to presenting client data consistently. 

“The day JP Morgan called us and we were able to get straight on the phone to our other banks to see what the opportunities were, it honestly felt pretty good. As time has passed, it’s clear to us that it was absolutely the right decision to use this multi-clearing model, and based on this, chances are that in relatively short order we will have at least one, and perhaps two more clearing bank in place. We’re not going to sit back and wait to see what happens,” confirms Seibald.

Those additional agreements are likely to be in place within a few months. 

To date, Concept Capital has arranged the orderly transfer of approximately 75 per cent of client AUM from JP Morgan and expects to have most completed shortly after the end of June. 

Those introducing brokers who have been unable to call upon other custody solutions face a difficult time; even if they start to develop a wider network of arrangements it takes a long time to integrate systems and train personnel to where they become proficient. 

There is a likelihood that some IBs will lose clients in the short term, making way for the possible further consolidation in what is already a fairly small mini-prime universe. According to Seibald, at the time of the JP Morgan decision, the bank had arrangements in place with a total of seven IBs.

“While there are a few smaller IBs still out there with other custody arrangements in place, some of those might not necessarily be with an established bank that would be desirable for managers with institutional-type investors,” notes Seibald.

Unsurprisingly, recent events have worked in Concept’s favour, allowing it to pick up client accounts from other IBs. It has caused a number of them to think about which client accounts they could make an effort to continue to service and those that they could not. That number of accounts that they cannot immediately find a solution for is not inconsequential. 

“We’ve been a beneficiary of that situation. We don’t know what the ultimate outcome will be, but my estimate is that our AUM related to the upheaval of the JP Morgan decision could well increase by 20 to 25 per cent come the end of summer,” suggests Seibald. 

The fact that JP Morgan is the first tier-one prime brokerage to make this decision throws up a number of existential questions:


  • What does the decision mean for IBs in a broader context? 
  • What does it mean in terms of the wider relationship that managers have with their prime broker? 
  • What does it mean in terms of the costs that managers are going to incur to maintain their PB relationships?

A lot of this is being driven by the regulatory impositions on banks – Basel III; the US Federal Reserve’s Liquidity Coverage Ratio (LCR) and requirement to hold High Quality, Liquid Assets (HQLA); MiFID II etc. 

What will those new rules mean in terms of the amount of capital banks need for different types of securities they are holding on their balance sheets? 

This is not just a concern for emerging managers who rely completely on IBs; it is also becoming a major headache for established managers who are getting culled from prime brokers or else facing higher trading and financing costs that allows banks to better justify each dollar they are using on their balance sheet.

“We can fill the void, but the question is how big the void becomes?” asks Seibald rhetorically. “Will another global bank decide to make the same decision as JP Morgan on pulling out of the clearing space? We’re not seeing any signs of that right now. 

“In fact, we have been approached by several large banks who have the ability to support IB business and are looking to potentially do business with us. I’m assuming if they are talking to us, they’ll be talking to other IBs as well, so it’s not all doom and gloom – there are other banks looking to fill the void. 

“That doesn’t, however, detract from the reality that this is a stressful period for hedge fund managers. It’s hard enough to run a portfolio, let alone having to figure out an alternative custody solution and trying to do it in a manner that causes the least disruption to portfolio management. It’s not a fun time for a lot of managers.” 

One of the known unknowns is whether IBs will further raise the bar in terms of the kind of account that they will be willing to take on. Seibald confirms that he is hearing that some brokers are making a conscious decision to terminate relationships with managers because the threshold, in their own minds of what an appropriate return should be for the services they are providing, is not being met. 

For the bank primes, they face three alternatives.

One is to shrink the balance sheet and keep pricing the same. Second is to change pricing and maintain the same balance sheet. Or three, some combination of both. 

“Banks are being more specific in their analysis of the assets on their balance sheet. They’re looking at accounts that use up balance sheet and trying to be more specific about the returns they are earning on the amount of balance sheet that each piece of business is using. As they go through this exercise, it’s probably a good bet that costs to hedge fund clients will go up; whether it is a higher cost on debit balances, on the short side of the book, leverage, or holding cash on a PB account. 

“Indeed, we’ve heard from some banks that they are imposing a fee on clients who are holding excess cash in their PB accounts,” notes Seibald.

As soon as Concept Capital were informed of JP Morgan’s decision, the most critical question they wanted answered was what the quickest way to transfer their clients’ assets with as least disruption as possible would be. 

“We figured it was important to present to our clients not just the information, but the potential solution all in the same message. Within 48 hours of being notified by JP Morgan, we had already communicated with all of our clearing firms, outlined what the options would be, and immediately began to communicate those options to all of our clients,” adds Seibald. 

This is something that clients appreciated. They understood that they weren’t going to be left high and dry and wouldn’t have to go through a number of disruptive procedures to affect the change. 

One can make an analogy to fund management and the importance of clear communication. Even if a manager suffers a major drawdown, provided they move quickly to inform their investors – rather than keeping their heads in the sand and hoping that no one will notice – and explain what has happened, chances are investors will take succour. 

Any time uncertainty lingers, clients bolt for the door. 

Concept Capital has managed to avoid this. 

“We went back to each client individually to discuss their portfolios, and recommended which one of our other clearing firms we thought would be best suited to their needs, and then left it to them to make a decision. In hindsight, what we did well was communicate the information we had as fast as possible to our clients in a clear and consistent manner. That made a big difference. Within a couple of weeks we already had a large number of clients saying, ‘Okay, we’re clear on the details so why don’t you just start the process of transferring our account’, for example. 

“As with anything, if you provide people with information that puts them in a position to make an informed decision, half the battle is won,” says Seibald

Seibald thinks that going forward it is going to become more difficult for smaller IBs who don’t have the capabilities – proper personnel, proper systems to provide clients with appropriate portfolio reporting, multiple clearing arrangements in place – to support managers. 

“The limitations will grow, and continue to justify our existence for being able to provide a broad range of services regardless of where the client assets are held in custody; that’s been our mantra for a long time and will continue to be what drives our continued market share growth,” says Seibald in conclusion.

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