One of the clearest manifestations of technology innovation is the way in which it is enhancing transparency in all aspects of the investment funds industry, from front-office portfolio analytics and trading cost analysis, middle-office investor reporting, to back-office compliance and accounting.
This is also benefiting prime brokers as they look to better service their clients and develop more trusted partnerships. One bank that is working hard to drive the transparency agenda is Societe Generale Prime Services.
“What we have discovered is the more transparent you are, the more things you put on the table at the outset, the better the relationship will be,” says Alexia Weiller, Global Head of Prime Solutions. “We want to build a mutually beneficial relationship by having investment managers understand our constraints but also by putting ourselves in their shoes.”
Over the last few years, hedge fund managers have sought to diversify their PB relationships due to counterparty risk, and also due to Brexit, diversifying between the US, Europe and the UK. As such, looking for the right long-term partner has become a carefully considered exercise, especially for smaller managers who have been jettisoned by larger tier one primes in recent years, simply for not being profitable enough.
This too has proven to be fruitful for Societe Generale Prime Services.
Admittedly, there is somewhat of a dichotomy between older established hedge fund managers and younger millennial managers, with respect to transparency expectations, but irrespective of this, Weiller says the long-term strategy is to deliver superior client service where managers know exactly what costs they are paying.
“Even though there might be tough conversations on the level of service, the expected level of profitability, etc, when you are grounded and transparent I think clients appreciate it and are receptive to it.
“The more sophisticated millennial managers are trying to automate things as much as possible with all of their service providers. To do that, you have to be more transparent. They are pushing us to improve and giving us new ideas. We continue to find new ways to interact with them,” comments Weiller.
It is fair to say that pricing among different prime brokers remains somewhat of a black box. Trying to compare the cost of shorting emerging market stocks across four or five different primes remains a challenging exercise.
But as Weiller is quick to state: “We’ve actually been trying to sell the pricing and analysis of profitability as a differentiating factor at Societe Generale Prime Services. What I mean here is being able to explain to the client what their capital and equity footprint is, how their business is impacting our balance sheet, and how we look at their business holistically across all different activities (depending on trading strategy) and products.
“If, at the end of that discussion, a manager wants us to be more competitive, we might suggest they change the duration of their rates portfolio, for example.
“We analyse the trading pattern of the portfolio manager to try to gain a deep understanding of how they trade and how it has an impact on capital and liquidity. Then we explain to the manager how we compute the numbers so that they can do it themselves. It is the opposite of a black box, in that sense.”
This ability to calculate the costs is advantageous to the buy-side as they prepare for MiFID II (which has just gone live at the time of publication). Managers will need to demonstrate to investors that best execution is being achieved for the fund and that trading costs are being properly managed. “We see a lot of managers wanting to disclose to their clients how prices are formed, what the logic is behind it, and the model we’ve had in place for the last two years enables them to do just that. We are happy to provide the price calculations, as opposed to just providing a number.
“We see ourselves as a trusted partner and as such, we feel it’s important to provide an end-to-end service. We provide balance sheet and liquidity, which come at a price, and we need to be able to explain it,” says Weiller.
In many respects this is re-shaping the PB service model. Knowing the economic value of a client is vital, given the expense involved for banks to use their balance sheets under Basel III, but that can only be truly achieved by understanding what the manager’s trading behaviour is in totality. This may sound obvious but one of the reasons some bank primes are showing clients the door is because they still operate legacy infrastructure where different divisions exist in silos.
This means a hedge fund with a modest equities book, a modest rates book, but a high volume FX book, might be shown the door, even though the aggregate level of business might be profitable.
Societe Generale Prime Services does not have that silo-based issue to overcome.
“We have given careful consideration over the last two years as to how we want to position ourselves and how we were going to differentiate our PB offering from the competition. What became a key selling point for us was the fact that the way the PB is set up at SG is very different to most other banks.
“It has not emerged out of a number of merger and acquisitions, which can lead to a natural split between the businesses where you have listed derivatives on one side of the bank, equity finance sitting within the equities division, the fixed income PB sitting within fixed income, etc. If you have a client who has interest across all those different activities, it will often not be evenly distributed.
“This has made it difficult for silo-based PBs to determine the client’s overall profitability.
“If you don’t combine repo with rates, or FX, or any other activities, and instead look at things on a standalone basis, it can lead to a difficult conversation with the fund manager.
“We come at this from a different angle, and look at what the manager is doing across all their trading activities. By doing this, it might be possible for one business to subsidise the other, as long as the overall relationship is balanced,” explains Weiller.
One of the obvious advantages to treating the client this way is that allows for cross-margining across different asset classes. If a manager has interest rate swaps and futures cleared under the same roof, they can achieve greater capital efficiencies by netting their margin and avoiding the complexity of handling margin calls for each different set of instruments being traded.
“We have a clear view of a client’s profitability across all the relationships it has. Other large PBs are trying to do this but it is not a natural way for them to look at their hedge fund clients.
“Prime brokerage is a bit like marriage. The more products one has with their PB, the stickier they are. Our message to the marketplace is, ‘Come and speak to us, test us on something and see what you think of our transparency’,” concludes Weiller.