Tabb Group: Prime brokers should prepare for Basel III
09 December 2014 London
Image: Shutterstock
New capital and leverage ratio rules could unfairly penalise prime brokers, according to a report by Tabb Group.
The report, Equity Prime Brokerage: Exploring Unchartered Territory, suggested that brokers could suffer is their securities financing operations are incrementally included as risk exposure, therefore requiring a capital buffer.
These rules will be phased in throughout 2015 under the Basel III regulations.
According to the report, the variable cost of financing and a reduction in prime broker relationships has led to the need for buy-side benchmarking and surveillance.
It suggests that the rules, combined with both changing treatment of collateral, and divergent costs of financing and long-only funds, are forcing a reassessment of benchmarking. At the same time, hedge funds and long-only funds are using fewer prime brokers in the wake of the financial crisis, a trend that is continuing downwards.
Radi Khasawneh, Tabb research analyst and author of the report, said: “In fact, the spread differential in the cost of long-and short equity financing with the six most frequently used prime brokers is as big as 95 basis points in the telecommunications sector alone.”
He added: “Complacency would be a mistake.”
Currently, brokers are focusing on key clients and their use of the bank’s balance sheet under new regulatory and pricing pressures. Khasawneh points out that Tabb has not seen any significant shift in the way clients are making choices, as new regulatory and clearing regimes pull equity markets in to the fixed income process.
The report suggests that an analysis of the future costs of trading will be necessary, and that this could also create an opportunity for hedge funds and long-only asset managers to put enterprise-preserving strategies in to place.
It cites changing attitudes within the industry in both the US and Europe. Historically, large, leveraged multi-strategy funds invested in expanded treasury functions that monitor the costs of financing compared to the risks, while a separate compliance division would focus on regulation.
Now, decisions will not be made on a case-by-case basis, but on an overall picture of performance based on a portfolio, the value of client flow and strategic goals. According to the report, efficiency is the key to achieving this, and should be considered the primary purpose of surveillance data.
Khasawneh said US and European funds should treat this as a priority, and avoid a ‘head-in-the-sand’ approach.
He said: “Its importance will only increase in line with costs. The fewer data points available in the normal workflow, the more important this is, so paradoxically the smallest funds have the most to gain from incorporating a surveillance strategy.”
The report, Equity Prime Brokerage: Exploring Unchartered Territory, suggested that brokers could suffer is their securities financing operations are incrementally included as risk exposure, therefore requiring a capital buffer.
These rules will be phased in throughout 2015 under the Basel III regulations.
According to the report, the variable cost of financing and a reduction in prime broker relationships has led to the need for buy-side benchmarking and surveillance.
It suggests that the rules, combined with both changing treatment of collateral, and divergent costs of financing and long-only funds, are forcing a reassessment of benchmarking. At the same time, hedge funds and long-only funds are using fewer prime brokers in the wake of the financial crisis, a trend that is continuing downwards.
Radi Khasawneh, Tabb research analyst and author of the report, said: “In fact, the spread differential in the cost of long-and short equity financing with the six most frequently used prime brokers is as big as 95 basis points in the telecommunications sector alone.”
He added: “Complacency would be a mistake.”
Currently, brokers are focusing on key clients and their use of the bank’s balance sheet under new regulatory and pricing pressures. Khasawneh points out that Tabb has not seen any significant shift in the way clients are making choices, as new regulatory and clearing regimes pull equity markets in to the fixed income process.
The report suggests that an analysis of the future costs of trading will be necessary, and that this could also create an opportunity for hedge funds and long-only asset managers to put enterprise-preserving strategies in to place.
It cites changing attitudes within the industry in both the US and Europe. Historically, large, leveraged multi-strategy funds invested in expanded treasury functions that monitor the costs of financing compared to the risks, while a separate compliance division would focus on regulation.
Now, decisions will not be made on a case-by-case basis, but on an overall picture of performance based on a portfolio, the value of client flow and strategic goals. According to the report, efficiency is the key to achieving this, and should be considered the primary purpose of surveillance data.
Khasawneh said US and European funds should treat this as a priority, and avoid a ‘head-in-the-sand’ approach.
He said: “Its importance will only increase in line with costs. The fewer data points available in the normal workflow, the more important this is, so paradoxically the smallest funds have the most to gain from incorporating a surveillance strategy.”
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