Choosing a prime broker: three considerations for emerging managers

The shrinking prime industry, coupled with a lack of innovation over the past 20 years, has created a challenge for emerging managers setting their prime brokerage strategy. Larger prime brokerage firms have limited appetite for emerging managers as they face changing trading conditions, new regulatory and capital requirements, and shifting macroeconomics.

Dependency on highly manual processes means that these firms cannot operate profitably with smaller funds, or with funds that have more sophisticated risk profiles or demanding trading strategies. Rather than service these clients properly, the dominant philosophy seems to be that the needs of the prime broker outweigh the needs of their small- and mid-size clients.

Building for scale with a full-service partner that understands their unique strategies is critical for emerging managers. These funds must focus on providers who offer high-touch service and are prepared to grow with their business. In seeking a prime broker for long-term strategy and success, emerging managers should consider:

High service levels are crucial for small- and mid-sized funds that can get left behind by larger institutions. Seek a prime broker with a reputation for delivering exceptional customer service and a consistent dedication to emerging and mid-sized managers, who will be there in stress with transparency, resources, and the balance sheet to allow the fund to maintain liquidity and stability when driving strategy and managing risk in all markets.

Ensure you have the opportunity to establish good relationships with the teams that support your business. Go beyond sales and coverage and consider risk, senior management, and value-added services focused on emerging managers, like cap intro, consulting, and technology tools. If the entire team understands your needs across asset classes, financial management, and business operations, you’ll be empowered to grow your business and focus on investors and risk.

To operate at peak efficiency, banks and brokers must reduce the manual processes that increase risk of error and operate in silos in favor of technology that empowers users to make smarter decisions and to identify potential risks throughout the trading process.

A modern prime broker has the potential to optimise operations across teams, asset classes and geographies, reducing cost, complexity and risk. An updated technology stack allows for automation, data insight, and scale in a variety of market conditions, driving efficiency and reducing operational frictions. In turn, high-tech firms can provide funds with front-, middle-, and back-office tools – like order management, risk management, and portfolio management systems – that improve automation and efficiency in their own operations.

Consider a firm’s regulators and financial resources and try to select relationships that are less likely to be impacted by changing strategies or commitments to the business line. As Common Equity Tier 1 (CET1) ratios come under pressure, banks will have to shrink their balance sheets and may cut hedge fund lending. Together with product offering, securities lending supply, and financing capabilities, a counterparty’s stability in volatile markets can be a key differentiator. Look for a prime broker that you can rely on in good times and bad to help establish a resilient business.

Total hedge fund assets under management are on the rise for the third quarter in a row as investors look to opportunistically position their portfolios while also preserving capital.^[1] Meanwhile, new regulations are fundamentally affecting the way prime brokers operate, and in turn, how hedge funds allocate their business.

Regulatory reforms required by Basel III have created space for new players to break into prime brokerage. A generation of new firms have the financial resources, capabilities, and bandwidth to establish market share and fill the void left by the established players who find themselves more constrained.

In tandem with market changes, these young firms can leverage modern technology without the constraints of legacy infrastructure and systems to give small- and mid-sized funds the services they need to grow their business.

^[1] The Full FX, Hedge Fund AUM Still on the Rise