Finding the perfect match
14 May 2024
Market participants discuss the inner workings of the prime brokerage industry, barriers to market, and the power of technology in creating a more profitable space. Carmella Haswell reports
Image: stock.adobe/Nipon
When it comes to selecting a prime broker, there is no “one-size-fits-all solution”. In today’s competitive market, prime brokers must demonstrate their ability to deliver across multiple components to capture market share effectively.
To find a suitable match, fund managers must assess all elements of a prime brokers’ offering as part of a detailed process to determine the best fit for their domicile and strategy.
James McAuslan, global head of prime services at StoneX, says execution capabilities, especially in managing multi-asset transactions across various geographies, and the range of financing solutions offered, are critical factors to consider.
In addition, risk management should be a significant focus area for the client, according to McAuslan. This can include the appropriateness of margin models and limit allocation, risk oversight or controls, and increased segregation options to add a higher level of protection for the client’s portfolios.
He adds: “The responsiveness and expertise of the client service team, the ease of use and connectivity of the broker's technology, along with the depth of reporting provided, can significantly influence the decision-making process.”
Evolution in the market
Prime brokerage is a group of services that investment banks and other financial institutions offer to large investment clients, such as hedge funds, which need to borrow securities or cash to engage in netting to achieve absolute returns.
The services provided by a prime broker revolve around facilitating the multifaceted and active trading operations of large financial institutions, including securities lending, leveraged trade execution, and cash management.
The prime brokerage market has evolved as the size, breadth and complexity of hedge funds has expanded considerably, says Ashley Wilson, global head of prime services at BNP Paribas. This evolution has required prime brokerage businesses and their staff to be able to manage a more diverse set of global products.
This practice now requires a broad expertise across financing, technology, risk management and relationship management. “Prime brokers can play a key role in enabling the growth of new strategies and the efficient allocation of capital in the markets,” Wilson confirms.
New technology continues to aid the prime industry; investments in technology and treasury expertise have resulted in a more efficient and profitable marketplace.
According to Taryn Siglain, global head of prime services at State Street, without advanced technology, primes cannot optimise their book, which will ultimately cost them in returns and hinder them from competing in this space.
Siglain assures that clients are investing in technology and people, specifically Treasury expertise, to ensure that they are able to optimally allocate to their providers. “These investments have resulted in a more efficient and profitable marketplace for those who have continued to invest in these ways,” she explains.
This market continues to evolve to meet the demands of clients, as well as to mitigate future market events, such as the collapse of Lehman Brothers in 2008, and more recently the demise of Archegos in 2021.
McAuslan comments: “These events led to initiatives to add stability to the market, such as central clearing of OTC products, increased capital requirements, and the introduction of the Uncleared Margin Rules (UMR).”
He elaborates that these changes in market structure have meant clients were required to diversify risk and seek alternative service providers, thereby accelerating the growth within the mid-tier prime brokerage space.
Barriers to entrance
When providing prime brokerage services, it is imperative that firms have a global footprint, and can provide clients with a wide product coverage, risk management, and a strong partnership. However, for new participants entering this space, there are a number of key barriers to consider.
Scale is imperative — as a new entrant into this market it can be difficult to build to scale in a timely fashion. State Street’s Siglain says the prime brokerage business is capital and liquidity intensive, and therefore requires a material up-front investment in technology to develop a competitive offering.
She adds: “We view stability as a core tenant to all of our relationships and one that can only be achieved at scale and with the right investment and commitment.”
There is an abundance of capital and strong bank balance sheets to support the liquidity needs of the hedge fund community. However, Wilson believes that the operational sophistication needed to facilitate the global multi-strategy and quant community requires a 5-10 year build, and sits within fewer than 10 banks.
He says that “this limits the financial resources available to support the hedge fund community and puts heightened emphasis on managing these resources efficiently”. New regulatory structures such as Basel IV also put additional focus on the ability of banks to maintain their client franchises. The strongest and best capitalised banks will be best positioned to service hedge funds over time.
Trends, demands and key priorities
As trends continue to shape the prime brokerage world, market participants have identified an opportunity for mid-market prime brokers to gain market share. This is due to Tier 1 firms repricing, or offboarding clients because of higher capital obligations, as well as the need to maintain their returns profile.
StoneX’s McAuslan believes this trend has led a number of mid-tier hedge funds searching for new prime brokers outside of the traditional bank providers.
He highlights additional trends in the products being delivered by these institutions, including clients demanding the “highest level of segregation for their assets”, as well as fixed income funds showing an interest in repo paired with custody, as a “more efficient” means of finance.
Speaking to Securities Finance Times, Siglain indicates that hedge funds are showing a demand in multi-strategy funds, which have seen a growth in terms of assets under management (AUM) and new launches. Demand across asset classes changes through market cycles, which has motivated State Street to offer clients financing across a number of asset classes, including equities, credit and convertible bonds.
Prime services’ revenues continue to increase as hedge funds grow their AUM and consume more services from their prime brokers, says Wilson.
He reveals that the business scope is expanding to “full collateral management optimisation” across multiple facets of the industry, with the largest benefit to UMR impacting clients. To meet this demand, BNP Paribas offers cross-margining solutions that allow clients to optimise their balance sheets while reducing their overall risk footprint.
State Street aims to remain focused on growing its footprint with new and existing clients and invest in its prime offering. The firm is in the midst of exploring a synthetic total return swap offering to fill a potential product gap, and ensure it can support its clients across more markets and jurisdictions.
In conclusion, McAuslan says StoneX will expand its team to meet global demand in this space. The firm offers fixed income-centric services, and will promote highly segregated custody solutions. As a response to client demand, it will also enhance cross-product reporting and margin capabilities to provide a “well-rounded” prime brokerage offering, suitable for clients worldwide.
To find a suitable match, fund managers must assess all elements of a prime brokers’ offering as part of a detailed process to determine the best fit for their domicile and strategy.
James McAuslan, global head of prime services at StoneX, says execution capabilities, especially in managing multi-asset transactions across various geographies, and the range of financing solutions offered, are critical factors to consider.
In addition, risk management should be a significant focus area for the client, according to McAuslan. This can include the appropriateness of margin models and limit allocation, risk oversight or controls, and increased segregation options to add a higher level of protection for the client’s portfolios.
He adds: “The responsiveness and expertise of the client service team, the ease of use and connectivity of the broker's technology, along with the depth of reporting provided, can significantly influence the decision-making process.”
Evolution in the market
Prime brokerage is a group of services that investment banks and other financial institutions offer to large investment clients, such as hedge funds, which need to borrow securities or cash to engage in netting to achieve absolute returns.
The services provided by a prime broker revolve around facilitating the multifaceted and active trading operations of large financial institutions, including securities lending, leveraged trade execution, and cash management.
The prime brokerage market has evolved as the size, breadth and complexity of hedge funds has expanded considerably, says Ashley Wilson, global head of prime services at BNP Paribas. This evolution has required prime brokerage businesses and their staff to be able to manage a more diverse set of global products.
This practice now requires a broad expertise across financing, technology, risk management and relationship management. “Prime brokers can play a key role in enabling the growth of new strategies and the efficient allocation of capital in the markets,” Wilson confirms.
New technology continues to aid the prime industry; investments in technology and treasury expertise have resulted in a more efficient and profitable marketplace.
According to Taryn Siglain, global head of prime services at State Street, without advanced technology, primes cannot optimise their book, which will ultimately cost them in returns and hinder them from competing in this space.
Siglain assures that clients are investing in technology and people, specifically Treasury expertise, to ensure that they are able to optimally allocate to their providers. “These investments have resulted in a more efficient and profitable marketplace for those who have continued to invest in these ways,” she explains.
This market continues to evolve to meet the demands of clients, as well as to mitigate future market events, such as the collapse of Lehman Brothers in 2008, and more recently the demise of Archegos in 2021.
McAuslan comments: “These events led to initiatives to add stability to the market, such as central clearing of OTC products, increased capital requirements, and the introduction of the Uncleared Margin Rules (UMR).”
He elaborates that these changes in market structure have meant clients were required to diversify risk and seek alternative service providers, thereby accelerating the growth within the mid-tier prime brokerage space.
Barriers to entrance
When providing prime brokerage services, it is imperative that firms have a global footprint, and can provide clients with a wide product coverage, risk management, and a strong partnership. However, for new participants entering this space, there are a number of key barriers to consider.
Scale is imperative — as a new entrant into this market it can be difficult to build to scale in a timely fashion. State Street’s Siglain says the prime brokerage business is capital and liquidity intensive, and therefore requires a material up-front investment in technology to develop a competitive offering.
She adds: “We view stability as a core tenant to all of our relationships and one that can only be achieved at scale and with the right investment and commitment.”
There is an abundance of capital and strong bank balance sheets to support the liquidity needs of the hedge fund community. However, Wilson believes that the operational sophistication needed to facilitate the global multi-strategy and quant community requires a 5-10 year build, and sits within fewer than 10 banks.
He says that “this limits the financial resources available to support the hedge fund community and puts heightened emphasis on managing these resources efficiently”. New regulatory structures such as Basel IV also put additional focus on the ability of banks to maintain their client franchises. The strongest and best capitalised banks will be best positioned to service hedge funds over time.
Trends, demands and key priorities
As trends continue to shape the prime brokerage world, market participants have identified an opportunity for mid-market prime brokers to gain market share. This is due to Tier 1 firms repricing, or offboarding clients because of higher capital obligations, as well as the need to maintain their returns profile.
StoneX’s McAuslan believes this trend has led a number of mid-tier hedge funds searching for new prime brokers outside of the traditional bank providers.
He highlights additional trends in the products being delivered by these institutions, including clients demanding the “highest level of segregation for their assets”, as well as fixed income funds showing an interest in repo paired with custody, as a “more efficient” means of finance.
Speaking to Securities Finance Times, Siglain indicates that hedge funds are showing a demand in multi-strategy funds, which have seen a growth in terms of assets under management (AUM) and new launches. Demand across asset classes changes through market cycles, which has motivated State Street to offer clients financing across a number of asset classes, including equities, credit and convertible bonds.
Prime services’ revenues continue to increase as hedge funds grow their AUM and consume more services from their prime brokers, says Wilson.
He reveals that the business scope is expanding to “full collateral management optimisation” across multiple facets of the industry, with the largest benefit to UMR impacting clients. To meet this demand, BNP Paribas offers cross-margining solutions that allow clients to optimise their balance sheets while reducing their overall risk footprint.
State Street aims to remain focused on growing its footprint with new and existing clients and invest in its prime offering. The firm is in the midst of exploring a synthetic total return swap offering to fill a potential product gap, and ensure it can support its clients across more markets and jurisdictions.
In conclusion, McAuslan says StoneX will expand its team to meet global demand in this space. The firm offers fixed income-centric services, and will promote highly segregated custody solutions. As a response to client demand, it will also enhance cross-product reporting and margin capabilities to provide a “well-rounded” prime brokerage offering, suitable for clients worldwide.
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