While regulatory costs continue to overhaul the industry, decisions amongst the buy-side over prime brokering will be increasingly driven by efficiency, as new financing strategies are beginning to take hold.
According to a report from research consultancy TABB Group, signs in Europe and the U.S. indicate a strong shift in attitude between how asset managers and hedge funds view their relationship with their prime broker.
Capital requirements and mandatory clearing prompting buy-side firms to take more responsibility in monitoring their financing costs, rather than relying on their relationship brokers to be a one-stop shop and data provider.
“Leveraged multi-strategy funds, such as Citadel and Millennium Partners, have long invested in a much expanded treasury function that monitors cost of financing in conjunction with a more sophisticated risk and compliance division that is focused on regulation. This model will be increasingly taken up by the wider buy-side as the funding environment shifts,” the report says.
In addition, regulation has resulted in asset managers relying less on their prime broker for execution services, with only 24% of hedge funds mentioning execution as major consideration in the choice of their prime broker according to a TABB survey.
The incoming Basel III capital rules are set to significantly impact the services of prime brokers, as many banks are already looking to scale back their operations and shift strategies.
Prime brokering and securities lending businesses, which traditionally had high balance sheet allocations, are now being reduced because of the Basel III capital rules. This is because the big banks will have to raise and put up more capital to carry out prime brokering.
“From 2008 a lot of prime brokers… had relative value strategies but now with Basel III, these strategies are highly inefficient, very balance sheet intensive, and have very low return,” Chris Caruso, president and founder of Pangea Business Solutions, an advisory firm for hedge funds, told delegates at an industry conference last week.
Furthermore, prime brokers will have to become a lot more selective in which funds they provide financing and other post-trade services for.
“We will not have the capacity to finance every fund, and to clear every OTC trade. With the announcement of some prime brokers leaving certain products, there will be a lack of capacity to service funds and banks,” added Gildas Le Truet, global director of prime clearing, ABN Amro Clearing, at the conference.
As the number of players in the space reduces, a do-it-yourself approach is becoming stronger amongst clients of the prime brokers, says the TABB report.
Credit Suisse is reportedly considering a downsizing of its prime services business, as the bank looks at targeting CHF70 billion worth of cuts as a result of the inbound leverage ratios.
Changing Buy-Side Strategies Will Shift Prime Brokering, Says Report
While regulatory costs continue to overhaul the industry, decisions amongst the buy-side over prime brokering will be increasingly driven by efficiency, as new financing strategies are beginning to take hold.