A New York-based prime brokerage head says he expects that the average cost to a hedge fund manager of using prime brokerage services will increase by five to 10 basis points over the coming year. “It’s too small to have a market impact for managers,” he says, “and, in any event, priorities have shifted away from selecting a prime broker based on cost.”
The price increase, he says, will occur as those prime brokers that, before the sub-prime crash, were underpricing their services in order to compete, have now been forced out of the market, or forced to increase their commissions in line with the industry. “The average cost across the industry will therefore naturally be higher. There is also the opportunity for some of the prime brokerages that have proved themselves to be sturdy and loyal to clients to put up costs as demand for their services increases and capacity for new clients becomes strained.” He believes that managers will decrease the number of prime brokers they have servicing them.
Stand by you
Events in the prime brokerage industry since last summer have caused managers to reassess how they select prime brokers, which is pushing them towards more established players. A hedge fund manager says: “It’s become very apparent which prime brokers will stand by you when liquidity temporarily dries up, and which will be dictated to from other corners of the institution and make unreasonable collateral demands.”
The long-term commitment to prime brokerage on the part of institutions has also been brought under scrutiny. Prime brokerage is a lucrative business, made more so since the ballooning of the hedge fund industry. As a result, financial institutions that have not traditionally provided prime brokerage have entered the market. Will their commitment persist? Bank of America’s announcement that it would be selling its prime brokerage business has aggravated concerns. In mid-January, the bank confirmed that it would be selling its equity prime brokerage business. Citadel was rumoured to be interested, although Jefferies appears to be a more natural contender. Six of Bank of America’s prime brokerage team left to join Jefferies at the beginning of 2006. Among those was the chief operating officer of Bank of America’s prime brokerage unit, Glen Dailey, who has reportedly expressed an interest in an acquisition of his former business.
Frank Magnani, managing director of SIP Prime, a mini-prime broker, says large prime brokers are under pressure to cut costs internally and increase revenues, regardless of market conditions. “Since the exchanges have gone from public to private, the exchange fees have risen. Large prime brokers are being forced to charge much more in execution to their clients because their overheads are staggering.” A hedge fund consultant doubts that the large managers will accept any form of price increase if it occurs. “Prime brokers just cannot charge more. The only way around charging more on financing rates and balances is to offer broader services such as fund administration and technology.”
Magnani believes that the prime brokers that will be able to attract and retain hedge fund managers will be those that can indeed offer a full range of services. “I don’t believe that managers are still looking for the lowest-cost provider. They are looking for a range of services with a prime broker that is committed to the business. We’re all under pressure to cut costs, but firms that are not subjected to the losses of other parts of the institution are going to be in a better position to expand their services and attract clients that are looking for new relationships.”
