Margins Being Squeezed In Prime Brokerage, Says Sanford Bernstein Analyst

Morgan Stanley, Goldman Sachs and Bear Stearns continue to dominate the prime brokerage business in terms of market share, despite the efforts of UBS, Citigroup, Lehman Brothers, Bank of America, Deutsche Bank, Credit Suisse First Boston and Merrill Lynch. Or

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Morgan Stanley, Goldman Sachs and Bear Stearns continue to dominate the prime brokerage business in terms of market share, despite the efforts of UBS, Citigroup, Lehman Brothers, Bank of America, Deutsche Bank, Credit Suisse First Boston and Merrill Lynch. Or so suggests Brad Hintz, an analyst at Sanford C. Bernstein, who published a report on prime brokers last week.

However, Hintz also notes that the competition to win hedge fund business is intensifying, putting pressure on the profitability of both market-leading and second tier prime brokers. Hintz reckons the leading prime brokers earn around $1 billion of revenue a year helping hedge funds run their day-to-day operations.

“While we believe that hedge fund assets will continue to grow at a healthy pace, we are forecasting prime brokerage revenues (securities and margin lending) to grow at a more moderate rate of 5-7 per cent over the next five years,” says Hintz. “This is due to margin pressure brought on by increased competition from new entrants in the market and the growing sophistication of hedge funds are playing one service provider against another.”

In the US, the most credible competitors are UBS, Citigroup and Bank of America, according to Hintz. Outside the US, Deutsche Bank, UBS and CSFB are the “toughest competitors.”

Hintz offers three strategies that would-be prime brokers can adopt for growth: acquire an established operation; grow an existing one; or specialise in a specific product. The first two options are the hardest. Acquiring an existing business has been done, UBS bought operations from ABN-Amro, but it can be costly. And growing an existing operation takes time. The niche strategy can work, Hintz says, but full service providers are also exploring new niches to make their customers happy.

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