“Our history is that we’ve been very welcoming to start-up hedge funds. Even as the opportunities to service larger managers grow, we’re not just walking away from what has been a significant part of our business,” says Jack Seibald (pictured), managing member at Concept Capital Markets LLC, one of North America’s leading introducing brokers.
Introducing primes like Concept Capital face a unique situation: on the one hand, they are well placed to grow as the quality and size of managers coming through the door increases as tier one primes reduce the number of managers they serve directly. On the other hand, they need to be careful not to stray away from their core audience; emerging managers, who need more support than anyone in these tough regulatory times.
“With each passing day we see additional evidence that the big banks are taking a hard look at their prime brokerage businesses. Goldman Sachs, Merrill Lynch, and JP Morgan, among others, have all been in the news on this subject in recent months,” says Seibald.
Recently, it emerged that Credit Suisse too was actively reviewing its prime brokerage business as the Swiss government considers raising the tier one capital ratio on its banks to 4 per cent.
This squeeze, facing many of the tier one primes, is manifesting itself through a more forensic assessment of the revenue potential of their clients.
“The unintended consequence of banking regulation is that it removes the capacity from the banking system to provide liquidity to the economy. The more you have to store away the less you have to lend; or conversely, the more you lend, the more you’ll want to earn.
“The fact that firms of the magnitude of Credit Suisse are thinking of paring back their prime brokerage business is going to lead managers to question whether they should start making alternative arrangements before they’re told to,” says Seibald.
It is estimated that benchmark revenues for hedge funds at large prime brokers are rising to USD500k annually.
“These numbers are not inconsequential. What will happen a year or two from now if in fact there’s a significant migration of these types of accounts from the big banks to firms like ours? Time will tell, but we’ve already begun to see certain introducing brokers informing clients that their revenue requirements are increasing from what they have been in the previous 12 months.
“If the industry keeps going the way it is, we too at some point may have to reconsider our position, and will need to decide whether it will make sense to increase our personnel to be able to service smaller, more marginal clients that can’t find a home,” says Seibald.
It’s a tough balancing act for all concerned. If leverage levels fall at tier one primes, as is expected – which will hit strategies like fixed income arbitrage – the corollary to that is that the banks will still need to generate revenues.
“If balance sheets are restrained, the less there will be to lend out, and banks will have to consider how to make up that potential shortfall in revenue. The obvious answer is by charging more for the amount they’re lending out. So spreads will widen going forward. Even as banks cull their hedge fund client numbers, I still think the cost of doing business as a hedge fund, especially on the funding side, is likely to go up,” concludes Seibald.