According to a report by compensation consultancy firm Johnson Associates, released in September, prime brokerage employees are expected to have the highest salary package increases this year in banking, at between 10% and 15%. That compares with investment banking, where compensation is expected to be between 5% lower and 5% higher than last year.
Compensation is growing largely a result of increased demand for prime brokerage talent, as banks realize that it is time to rebuild after the crisis. UBS made five senior hires in Hong Kong in August for example.
The competitive landscape of prime brokerage since the financial crisis has opened up opportunities to a broader spectrum of players. In a market previously dominated by broker dealers Goldman Sachs, Morgan Stanley and Bear Stearns, the top five players are now mainly universal banks.
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“The old broker dealers still struggle with locked margins for a term period, but banks can set that up” Jon Hitchon, Deutsche Bank |
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“There was a feeling that after the crisis clients might return to the surviving former broker dealers but instead several universal banks that made inroads have now cemented their positions,” says Jon Hitchon, co-head of global prime finance at Deutsche Bank in New York. Indeed, the trend now for hedge funds when selecting prime brokers seems to be to have Goldman Sachs plus a bank. Hitchon says as hedge funds become more institutional, having a banking relationship becomes crucial, particularly when it comes to supplying longer-dated lending. “The old broker dealers still struggle with locked margins for a term period, but banks can set that up. Bigger and more complicated funds need that so they can better manage their assets and liabilities and not have to force sell to match margin calls. In some ways prime brokerage is evolving into prime banking.”
It is still early days, however, for a move to more bank-like long-dated lending. John Willian, global co-head of prime brokerage at Goldman Sachs, says his firm for now doesn’t offer long-dated secured or unsecured lending off its balance sheet to clients but that has not affected business. Goldman Sachs’s market share remained flat during the crisis and has risen slightly since. Willian says this type of financing is something it can consider now it is a bank holding company, and will. “As yet, we haven’t seen much demand, but it’s something over the next year we will be looking at.” Long-dated financing isn’t for every client though. Willian says: “The cost of borrowing is much higher for a start, and that can be particularly challenging in the current environment.”
For now Dean Backer, global head of prime brokerage sales and capital introduction at Goldman Sachs, says the basic prime brokerage services such as capital introduction, reporting and securities lending are still most important to clients.
Alongside Goldman Sachs, the top-five prime brokers by market share are now JPMorgan, Credit Suisse, Deutsche Bank and Morgan Stanley. Credit Suisse’s rise to the top-three prime brokers globally has largely been a result of its ability to retain clients over the crisis. Indrajit Bardhan, head of prime services risk and head of prime services Americas at Credit Suisse, says the firm has always been selective about clients it takes on, which has helped. “It meant that when the crisis hit, we could protect the clients we had. That strategy of being a long-term partner really showed the value of our business,” he says. Other prime brokers took on too many clients leading up to the crisis as they aggressively expanded and were forced to get rid of some as credit tightened.
Firms that lost market share during the crisis are now reinvesting. UBS and Citi are rebuilding their businesses, Barclays and Nomura are expanding on the prime brokerage capabilities that Lehman Brothers brought them, and Bank of America is now back in the game with Merrill Lynch’s prime brokerage franchise. Competition is heating up.
Steve Keller, head of Americas financing sales at Bank of America Merrill Lynch, says the firm has added a record number of accounts in the year to date. His firm has been aggressively hiring globally as it builds out its prime brokerage business.
Now that JPMorgan has a solid position in the US, it is building out in Europe. Andrea Angelone, global co-head of prime brokerage at JPMorgan, says the firm has been hiring in London, adding heads to distribution, consulting, capital introduction and product development.
But given market conditions, is it wise to invest? Hedge funds have returned an unimpressive 1% on average this year so far. Hitchon says equity long/short and quant funds have found this year tough. “Equity markets are responding to macroeconomic data rather than fundamentals as the never-ending debate about a double dip continues. That means correlation among stocks has been high, and for stock pickers that proves very challenging.”
Uncertainties about the economic environment are also keeping a lid on the amount of leverage that hedge funds are employing. That was OK in 2009 when financing spreads were at all-time highs. This year, though, prime brokerage revenues are down about 15%, one analyst estimates.
Keller says that in spite of the difficult environment, it is essential to compete in prime brokerage because the hedge fund industry can only grow. “An increasing number of public plans and corporate plans are dealing with asset liabilities mismatches,” he says. “Some have 7%-plus return rates they need to achieve so they are going to be ramping up their allocations to alternatives over the next few years.”
Given the new assets that might be flowing in, it is no surprise that capital introduction is a key area where the prime brokers are ramping up. “It’s a primary selling point. Hedge fund managers focus first on performance, and then on gathering assets. If the prime broker can aid in that hunt of assets, the relationship will grow from there.”
The race is on, however, to convince hedge fund managers of a long-term commitment to prime brokerage. Lou Lebedin, global co-head of prime brokerage at JPMorgan, says he expects hedge fund managers to start to consolidate their providers. “We are expecting managers to have to reassess their number of prime brokers due to assets under management remaining flat and leverage still modest. They will want to consolidate to counterparties that not only offer them great prime brokerage services but also give them access to other investment banking and banking capabilities.” He says he expects his firm’s market share in prime brokerage to continue to grow.
