Prime Brokers' Capital Challenges Are Becoming a Reality

As a result of new capital requirements stemming from Basel III, prime brokers have had to cut ties with less profitable clients, such as with Bank of America cutting 150 clients, as first reported by Bloomberg.
By Jake Safane(2147484770)
As a result of new capital requirements stemming from Basel III, prime brokers have had to cut ties with less profitable clients, such as with Bank of America cutting 150 clients, as first reported by Bloomberg.

A source told Global Custodian that the cuts happened approximately five or six months ago, around the time reports surfaced that Goldman Sachs had made cuts of their own.

“It is indicative of what’s been happening at all of the major prime brokers,” says Jack Seibald, managing member at Concept Capital, an introducing prime broker.

While there hasn’t been a new round of cuts of late, prime brokers seem to be continually evaluating which relationships work, and more funds will face the prospect of either being told they have to go to another prime broker or that they have to pay higher financing charges.

Seibald says that while he thinks that the pace of prime brokers cutting ties with hedge funds may settle down, “there’s going to be an ongoing process of funds being called in by their prime broker to discuss the issue of revenues. I think that part is going to be ongoing, probably at a reasonable clip.”

For those funds that are told to go elsewhere, they likely won’t be able to move their book to another large prime broker, as the problems would tend to be the same. However, smaller prime brokers have been able to absorb these funds, for now at least.

“I haven’t yet heard of any that haven’t been able to land another home, but at some point I suspect we will hear about those,” says Seibald.

If a fund can’t find a prime broker, he posits that perhaps the fund could go to a traditional custody bank who can hold the assets for a fee, but these banks may not be able to handle shorts and derivatives. Or perhaps big hedge funds will even become lenders themselves, but the solutions are not exactly clear at this point.

From this point on though, these challenges look to become only more prominent.

“As an industry, it’s highly likely that conditions as it relates to prime brokerage are going to get tougher,” says Seibald.

«