Two years ago, Wells Fargo Securities, the capital markets and investment banking arm of Wells Fargo, acquired Merlin Securities, an introducing prime broker, which allowed Wells Fargo to make its entrance into the prime brokerage industry. Since that time, the bank has been developing a self-clearing offering, which recently received approval from the Financial Industry Regulatory Authority (FINRA) to launch the offering. Eamon McCooey, head of Prime Services at Wells Fargo, joined the bank last year after serving as head of U.S. prime brokerage at Deutsche Bank, and he has since led Wells Fargo in its prime brokerage growth during a time of regulatory constraints.
GC: How has Wells Fargo’s prime brokerage offering grown since the acquisition of Merlin?
EM: Merlin was acquired in August 2012 as part of a strategic plan to build out a prime brokerage capability within Wells Fargo Securities. At the strategic level of the bank, they realized that in building out a comprehensive investment bank, most investment banking platforms had a prime brokerage business, so Merlin was the first step in building out the prime brokerage capabilities. At the end of 2012, Merlin was rebranded Wells Fargo Prime Services, and Wells Fargo Prime Services was one of the leading introducing prime brokerage platforms, where we focused traditionally on emerging managers and basically introduced them to clearing brokers. Our clearing brokers traditionally provided the traditional prime brokerage offerings of margin lending, securities financing, and clearing and custody of the assets. Wells Fargo Prime Services wrapped it with a technology layer as well as cap intro services and the traditional client service model on top that. So that was our first foray into the prime brokerage space.
At that point in time, the bank also realized, given the liquidity and balance sheet advantages that Wells Fargo had, that we wanted to go and extend the prime brokerage platform into offering self-clearing capabilities, where Wells would do the traditional prime brokerage servicing of securities lending, margin finance and extending the balance sheet of the bank. At the time of the purchase [of Merlin], we initiated a program that’s now been approximately two years in the making, to really build out our platform capabilities and infrastructure to be able to offer self-clearing to larger, institutional alternative asset managers that traditionally would not fit in the introducing brokerage model.
GC: What has it required in order to build out the self-clearing capability?
EM: At its core, prime brokerage is an extension of an institution’s capacity to provide alternative asset managers a firm’s excess technology, operation and balance sheet resources. Over the past two years we have been working to ensure we have the appropriate infrastructure and human resources to support this offering. This has included a comprehensive build out of our custody and settlement systems, compliance and regulatory monitoring and reporting capabilities while at the same time leveraging off the existing legacy Merlin reporting infrastructure. We’ve also been onboarding experienced prime brokerage staff that have worked in firms with large prime brokerage offerings across sales, capital introduction, product development and new business management. Also our partners within legal, compliance, technology, regulatory reporting, credit and operations have added experienced staff to support our offering.
GC: Will you offer self-clearing alongside the introducing brokerage model?
EM: We still plan on operating the two models. We feel that the legacy Wells Fargo Prime Services platform is a market leader in the emerging manager space, and we will continue to focus resources and build that out, but at the same time, we realized it was an advantage to us to be able to offer to the larger alternative asset managers as well. So it is a model that, under the same business unit, we’ll focus on two different client subsets.
GC: Because of new regulations, will it be difficult bringing clients onto your balance sheet?
EM: Right now, there is definitely a regulatory impact of Basel III that is starting to permeate through the prime brokerage space, and the general consensus is that it will have a significant impact on the prime brokerage landscape. These businesses were traditionally self-funded. They had a sizable balance sheet allocation, but they really didn’t require large amounts of capital to operate. Under Basel III, the regulatory regimes wanted to basically put in three things after the financial crisis: they wanted to increase the bank’s capitalization, instilling higher capital requirements to transact certain transactions; they wanted to reduce liquidity risk with the establishment of some liquidity metrics such as the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR); and they wanted to constrain leverage with implementation of the supplementary leverage ratio (SLR). So when you look at businesses like prime brokerage and securities lending, which traditionally had high balance sheet allocations, as the new regulatory footprint comes into play, banks are looking at reducing their balance sheet because of rules such as the supplementary leverage ratio. They’re looking at putting higher capital toward transacting in certain businesses, so businesses such as prime brokerage, which traditionally did not require a lot of capital, are going to attract more capital. And then with the liquidity risk, banks are traditionally looking at matched funding. In the prior space of the old prime brokerage models, they would fund overnight funding through internalization, through securities lending or tri-party repo. It’s now looking to match your term funding that you’re giving out to clients, and that’s obviously going to have a bigger expense.
So I think there’s a fundamental review within the prime brokerage businesses now of understanding who their client base is and understanding what metrics are important to them as an organization, whether that’s Return on Assets (ROA), Return on Equity (ROE), CCAR (Comprehensive Capital Analysis and Review, the Federal Reserve’ stress test), [etc.]. These are metrics that are now driving prime brokers to basically do a thorough review of their client base, and I think the challenges are in some of these strategies that don’t fall within the HQLA (high quality liquid assets) definition of LCR. There’s going to be a challenge to fund those strategies, and if you’re going to fund them, they’re probably going to be more expensive. I see that there’s continued investment into the alternative space, but given the bank capital and leverage and liquidity rules, balance sheets are shrinking, so there’s appetite for additional liquidity providers to come in and fill that gap. We look at Wells as being a well-capitalized bank and being one of the safest counterparties in the world, so we obviously see an opportunity to be a financing provider to hedge funds, given the strong and liquid balance sheet. However, we also need to look at the metrics that are important to us, and we want to grow with the right counterparty, assuming that we can get the right asset mix into the bank.
GC: What metrics are important to you? And do you foresee financing costs increasing, or is it more the case of being more selective with the clients you take on?
EM: I think we want to partner with the right clients. The metrics that are important to us are CCAR, obviously we’re part of the Fed stress tests, so that’s important; with LCR, it’s about understanding the impact of LCR as you bring in client assets, because the definition of LCR limits the assets you can apply to as having stable assets—so equities fall into that, government sponsored entities, cash, government securities—for assets that fall out of that, you have to ensure that you have liquid assets to cover in case of any outflows of capital to ensure you have a liquid book. For us, it’s important we understand the clients and understand the right strategies. What you want to be able to do is engage your clients in a thoughtful conversation and tell them what’s important and how they can structure their business to you to make the portfolio more efficient. Now not all clients have the ability to pull those levers; everybody would like the U.S. equity long/short manager, but maybe a manager is a credit manager, or they’re a long only or a short-biased manager, and they may not have all of those levers to push to be able to make themselves more efficient from the metrics that you’re looking at. So what we also look to do is look at the manager from a holistic standpoint to try to understand what is the value of that manager to the organization and does the manager have a strategic relationship. We feel that if the manager is a good partner and is engaging in multiple business lines, we look at it from a holistic standpoint. So if they have a relationship with our fund administration business, if they’re using our electronic execution capabilities, [etc.], we try to look at that as a measurement. At the end of the day, we want to look at our business as a standalone business as well, but we try to be as efficient as possible given the new regulatory framework.
GC: What advantages do you foresee in having both the self-clearing and introducing brokerage offerings?
EM: When you look at the introducing broker platform, that’s traditionally been a sweet spot for emerging managers—managers that are in the very nascent status of their development—and traditionally a lot of those managers…don’t fit well in the big bulge bracket firms. Those firms don’t really understand those managers as well. Those managers typically require high-touch service on the cap intro side, and they typically require a little bit more of the high-touch service from the client service side because they’re running smaller shops that may not have the infrastructure or the framework that larger managers have. So they typically like that introducing broker model because they can get access to cap intro resources and other resources across the organization that you may not get in the bulge bracket firms.
As those managers start to retain a track record and go out and attract funds and grow, they now become very much attractive to the larger prime brokers, because they now have sufficient financing assets, securities lending, margin debits, [etc.], where it may make and meet internal thresholds that the larger primer brokers attach to client opportunities. By just having the introducing broker model, traditionally when we had a manager that we took from cradle and started to grow and develop that manager, then suddenly they became attractive to the larger prime brokers. With the introducing prime brokerage model, that was one of the disadvantages that the client would move onto a larger prime brokerage platform. We feel now that given we have the introducing model, and the focus and priority will still be on that, as well as our self-clearing, they can grow up in the introducing broker platform, and then maybe over time, they can migrate onto our self-clearing platform.
Another advantage of having a self-clearing offering is the ability to attract large institutional managers that can pay an institution in other ways outside of PB, such as electronic execution, cash trading, trading OTC derivatives and utilizing the private bank for personal finances. Also the large institutional alternative asset managers control the overwhelming wallet share within the prime brokerage space.
GC: Are there any other areas or offerings you’re looking to build out?
In addition to the prime brokerage platform, we have built out an FCM (futures commission merchant) and OTC clearing business, which is aligned very closely with our prime brokerage platform. We have a very mature fund administration business, and those three businesses tend to be very much aligned; prime brokerage clients tend to use fund administration as well as FCM and OTC clearing. As it relates to prime brokerage, we’re in the early stages of a platform build-out, so over the next few years, we’ll continue to automate, expand our operational capabilities, and continue to extend our technology capabilities to have more straight-through processing. We are also very aligned to, as our clients grow and extend their product capabilities, growing our platform with our clients.
GC Friday Interview: Eamon McCooey, Head of Prime Services, Wells Fargo
Two years ago, Wells Fargo Securities, the capital markets and investment banking arm of Wells Fargo, acquired Merlin Securities, an introducing prime broker, which allowed Wells Fargo to make its entrance into the prime brokerage industry. Since that time, the bank has been developing a self-clearing offering, which recently received approval from the Financial Industry Regulatory Authority (FINRA) to launch the offering. Eamon McCooey, head of Prime Services at Wells Fargo, joined the bank last year after serving as head of U.S. prime brokerage at Deutsche Bank, and he has since led Wells Fargo in its prime brokerage growth during a time of regulatory constraints.
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