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Risk concerns target strong balance sheets

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Interview with Chris Barrow The tumultuous events of the eurozone debt crisis, which sent the markets into a tail spin this summer, have caused a lot of headaches for investment professionals. But for HSBC’s Prime Services offering, which launched around the time of Lehman’s imploding, this year’s volatility has actually been playing right into its hands.

This has, in large part, been down to investors and managers alike scrutinising the strength of prime brokers’ balance sheets, and more importantly, determining whether their assets are being held somewhere safe.

“We launched Prime Services in response to client demand really. Hedge fund clients we knew were asking us to step into the void, post Lehman’s, and offer them a custody-based solution. Investors were nervous, as were the managers,” explains Chris Barrow (pictured), HSBC Prime Services’ global head of sales.

Prime Services evolved out of the HSBC Bank global custody platform, a custodian in 96 global markets. This allows the bank to offer a fully integrated ‘prime custody’ solution, the two businesses sitting side by side under the HSBC Bank Plc umbrella.

Concerns over counterparty exposure have ebbed and flowed the last couple of years but as Barrow notes: “With the eurozone crisis rumbling on and becoming more of a worry, counterparty credit and the issue of protecting clients’ assets has moved to the top of the agenda. We’ve seen a clear increase in interest.”

Currently, Prime Services has more than 50 global fund managers going through the onboarding process and putting a structure in place.

As well as offering all the usual prime brokerage services – leverage, financing, securities lending, market access, trade execution – Prime Services provides segregated accounts for client assets as part of its global custody offering. It is not, therefore, a standalone custodian like BNY Mellon for example. “Within segregated accounts we only need to take a charge on client assets as and when they build up exposure on the trading side and we start lending them money,” notes Barrow.

Bigger multi-billion dollar hedge funds typically have separate custody arrangements but this requires the broker and custodian to efficiently move assets back and forth on clients’ instructions. “What we can do is offer both those services with HSBC. It’s a more streamlined operational process,” says Barrow.

He adds that today’s eurozone pressures, which started as a country debt issue, are migrating into the banking sector and that what we’re now seeing in the market is a capital and liquidity squeeze, which is being further exacerbated by regulation. Basel III and the FSA’s liquidity regime are increasing capital and liquidity ratio requirements and “putting more stress on the free flow of funding. That’s also affecting hedge funds in terms of managing their own balance sheets.”

A strong balance sheet, then, is probably more important to prime brokers than ever before. Barrow considers it a huge factor: “Aside from performance, which is important, I believe that’s investors’ primary concern. Investors are more closely looking at the balance sheets of their prime brokers.”

“They want to know: is my broker going to receive stable funding during times of stress? Are they confident the terms of their margin or swap financing are going to be consistent? I think there’s a lot more focus now on stability of funding and liquidity rather than price of funding and liquidity.”

Please click here to download a copy of the Hedgeweek special report: The Evolution of the prime brokerage model – Challenges & opportunities 2011

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