Prime brokers urged to do more

Speaking at the International Securities Lending Association (ISLA) 2015 conference in Lisbon, hedge fund panellists collectively argued that they are receiving conflicting messages over financing from their prime brokers, leaving them with a number of challenges in the post-Basel III environment. “It’s not just t

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Speaking at the International Securities Lending Association (ISLA) 2015 conference in Lisbon, hedge fund panellists collectively argued that they are receiving conflicting messages over financing from their prime brokers, leaving them with a number of challenges in the post-Basel III environment.

“It’s not just that the message from the prime brokers isn’t clear, but it isn’t consistent – and that makes it difficult for us,” says Russell Hart, COO and founding partner of Alcova Asset Management.

“The prime brokerage model has gone from, historically, being very much of ‘we will do everything you want’ to slowly being a bit more selective, now even on occasion passing you to other banks.”

Many of the largest prime brokers, such as Barclays, Credit Suisse, Bank of America, Deutsche Bank and J.P. Morgan, are shrinking their prime services division in the wake of increased capital requirements.

This has led to many hedge fund clients at the mercy of these cuts, in which the leverage ratio and the liquidity coverage ratio (LCR) in Basel III are forcing prime brokers to review their hedge fund relationships, and are becoming much more selective over what parts of the portfolio they finance.

Even though some hedge funds are trying to make themselves more attractive by saying they will use the prime broker for additional services such as execution, the vigilant stance taken by the prime broker is having far-reaching consequences on its internal organisation.

“We are giving prime brokers business, which includes credit balances, which they now don’t want. There is also plenty of execution and other business to go with it, which they presumably do want. [But] Basel III has just changed that whole dynamic, and has forced prime brokers to silo their business whereas we still look at it as one organisation,” says Richard Haas, COO of Capeview Capital, a hedge fund with over $2 billion in assets under management (as of June 2015).

One reason why banks are becoming reluctant to take on added business is because they are still facing conflicting messages from the regulations.

“To an extent, the industry hasn’t been consistent in what it wants, but nor have the regulators. The regulators have articulated what their grand vision is, but the devil is in the details,” says John Duckitt, vice president, EMEA Prime Brokerage Risk, Nomura.

In addition, prime brokers are still devising their future strategy, so taking on new business which could hinder their position in the new regulatory environment would be counter-productive.

“At a much higher level, banks are trying to work out what they look like as an institution in 2020,” adds Duckitt. “As banks start to crystallise their five year/ten year strategy, most will have leverage ratio at the forefront of their minds.”

According to the panellists, the answer to navigating the regulations comes down to having more conversations with their prime brokers to understand what and where the constraints are.

“We would like a clear assessment in the sense of what is running from the top of each investment bank down through each of the core businesses, and distil itself so we can isolate different organisations,” says Matthew Johnson, COO and partner, Makuria Investment Management.

“We’ve generally been a relationship driven business, in which we put a lot of stock into our relationships from day one. But that is eroding due to regulations, and we have to deal with that.”

Hedge funds may still be unsure over what the prime brokerage model will be going forward, but consistent messages from the banks will be vital to ensure stable financing.

“We have searched for efficiencies to improve returns, but we have not yet done as much as we can,” says Ermanno Dal Pont, managing director, Barclays Capital.

“We are sitting down with clients to discuss their portfolio, understand their needs, and find reasonable solutions for us to meet that required return increase without necessarily using the lever of pricing.”
– Joe Parsons

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