In just six months the make-up of the prime brokerage market has completely changed. Previously dominated by Goldman Sachs, Morgan Stanley and Bear Stearns, the industry looks set to be led more evenly by about six key players, with hedge funds dividing assets among them rather than having a core prime broker.
Nervousness about the future of the independent investment banking model caused many hedge fund clients to reduce their exposure to Goldman Sachs and Morgan Stanley in September, say staff at other prime brokers.
One head of prime brokerage at a bank says that the collapse of Lehman Brothers led to the latest surge of movement among prime brokers. Panic ensued when Lehman announced bankruptcy in September and billions of dollars-worth of prime brokerage assets were frozen at the European arm of the bank. Although Lehman was rarely a sole prime broker to hedge funds, and was rather used as add-on for specialist needs in fixed income or enhanced financing, its bankruptcy and freezing of assets caused hedge funds to question all of their prime brokerage relationships. "For a couple of years now, large sophisticated hedge funds have been diversifying their prime brokerage providers but the Lehman debacle really focused people’s minds on where their assets are being held," says the banker. "There was a herd-like rush following the Lehman bankruptcy of hedge funds moving accounts."
Barclays has bought Lehman’s US investment banking business, which does include prime brokerage, but a spokesman says it is too early to say what will happen to that business. One prime brokerage head says he thinks Barclays will want to distance itself from Lehman’s prime brokerage business. "Barclays has a strong fixed-income prime brokerage model that seems to work," he says, "and I think it would be too much of a headache to try to take on Lehman’s clients what with the frozen assets. Clients are naturally upset about how they have been treated by Lehman and they are likely to remember that."
Hedge fund sources say that JPMorgan, Credit Suisse and Deutsche Bank have been the main beneficiaries of the movement of assets. UBS has also seen inflows, say market participants, offsetting outflows experienced earlier in the year.
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"The larger prime brokers simply do not maintain the resources to properly service funds of all sizes"
Mike Murray, Shoreline |
Smaller prime brokerage firms say they have also seen inflows of assets in recent months. Mike Murray, partner at broker/dealer Shoreline Trading in New York, says his firm has enjoyed a dramatic uptick in new business. He says, in particular, that small hedge funds are no longer being serviced by the large prime brokers. "The larger prime brokers simply do not maintain the resources to properly service funds of all sizes, and will rely on firms like Shoreline to service those managers that fall below their internal thresholds."
Jon Hitchon, head of global prime services at Deutsche Bank in New York, believes that the time of having a sole prime broker, particularly for equity long/short funds, is over. "We will more likely see six or so main prime brokers that share clients," he says.
Candidates for those top six or so places are different to those that might have been suggested six months ago as the make-up of US prime brokerage has been further altered by recent sales and acquisitions. Bank of America, which recently sold its prime brokerage business to BNP Paribas, has re-entered the business through the acquisition of Merrill Lynch. Bank of America said it was too soon to know what the plans for that business line would be but onlookers say it is not as bizarre a move as it seems. "Ken Lewis [Bank of America’s chief executive] has made it clear he wants to be number one or two in every line of business," says a senior prime broker in New York. "Prime brokerage as a standalone product does not make sense. It has to be embedded in sales and trading so it made sense for Bank of America to exit prime brokerage. As part of the entire Merrill Lynch business, prime brokerage makes sense and I would think Lewis will want to keep it and grow it. It remains to be seen whether the distractions of digesting the acquisition affects that growth." The sale of BofA’s prime brokerage business to BNP Paribas also propels the French bank into the US prime brokerage top 10 rankings. It also claims strong inflows since September’s market mayhem.
Those that want to be in the top six will have to go back to basics, says Hitchon. "There have been a lot of distractions in prime brokerage as competition has increased, in a bid for differentiation. That pendulum swung too far and now it’s back to the basic questions of ‘Do you have balance sheet? How is your balance sheet funded? How good is your institution as a going concern, and will you lend me money?’"