Competitive forces in the prime brokerage space: Is bigger always better?

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3 factors to consider when choosing a prime broker

In recent years, bulge bracket prime brokers have been prepared, in certain cases, to lower the threshold for what size of funds they will take on. Depending on where the funds are based and what kind of pedigree they have, the larger prime brokerage providers have been known to offer their services to funds with as little as $25 million in assets under management.

One can see why this has felt like a win-win. New funds or those with modest amounts of assets under management have been keen to secure the services and reputational lustre that come from having a major player as their prime broker. And the providers have been eager to boost their fee revenues and balance sheets.

But for small- to mid-sized funds, there are multiple reasons to think carefully about the selection process and not necessarily adopt a position that bigger is always better.

One is the churn factor. Funds with lower AUM totals need to be able to grow and generate a certain level of revenues within a relatively short timeframe, or they may find their prime brokers offering limited service – or even ready to offboard them. A second is that the prime brokerage sector itself is in a state of flux, which could change the way bulge bracket providers do business. And a third is that funds may want a higher level of contact and attention than the largest banks are in a position to offer them. For many funds, this last factor could be the most important.

1. Churn: Under pressure

Bulge bracket firms may be prepared to take on some funds with less than $50 million in assets, but that does not mean they will keep them as clients indefinitely. Many of these banks have revenue pre-requisites. Or, they may have a timeframe during which they expect clients to grow. If either the revenue or the growth is not forthcoming, there will be pressure for the banks to offboard the funds. That kind of upheaval is the last thing that a hedge fund needs.

Some of the churn may be the result of external factors. For instance, Credit Suisse said at the end of 2021 it would close most of its prime brokerage business, and bulge bracket firm Nomura has recently scaled back its prime brokerage activity. While other bulge bracket firms may be keen to pick up some of those firms’ clients, providers could become more selective. With fewer bulge bracket brokers competing, funds can expect prospective prime brokers to be even more discriminating.

Whenever funds are forced to switch to new prime brokers, or decide to do so of their own accord, they have new processes and personnel to deal with. In such cases, funds would do well to focus on providers that have a simple, high-touch approach to servicing clients. Fund managers don’t want to waste time hunting around for the right desk or person to talk to.

2. Flux: In the spotlight

The regulatory environment means prime brokerages are likely to become stricter in their dealings. The U.S. Federal Reserve has voiced its concern about how prime brokerage relationships are managed and how margins are set, while the Bank of England is worried about “significant cross-firm deficiencies” in lending practices, onboarding arrangements and how client arrangements are continuously assessed.

The Bank of England has called on British banks to conduct a systematic review of equity financing and risk management practices. Cowen has noted, for instance, that risk management models may need to be more flexible to adjust to new situations, such as the meme stock phenomenon that emerged last year.

What all this means is that prime brokers may be obligated to adjust their practices, either suddenly or in ways that hedge funds are not prepared for. Our approach has always been conservative. We want to avoid funds experiencing a yo-yo effect with margins, one that could affect their ability to execute their strategies. For firms that have multiple prime brokers, it’s also worth noting that changes in margins can also have a knock-on effect due to cross-default provisions.

3. Attention: Closer contact

One of the issues with the bulge bracket providers is that they are not always able to offer the amount of contact that a fund requires. Depending on the services needed, whether that involves capital introduction, lending or consultancy, emerging funds may require extra attention. They need their calls returned on the same day, and they need to avoid getting passed around from one department to the next.

There also may be a perception that only the largest prime brokers can offer the full range of services. That’s not the case, and Cowen is a good example of the kind of prime broker that can blend full capabilities with a high-touch approach.

A lot of funds, either because of their size and geographical spread, or because they want their money held with different custodians, will have multiple prime brokers. Many of these may have relied on two or more bulge bracket providers. But in some cases, it could make more sense to consider diversifying by having one bulge bracket provider and a second prime broker, such as Cowen, that can offer the full suite of services and more personal contact.

Many of Cowen’s clients fall into this category, which can also mean dealing with different reports from different custodians. One of the services we offer, which has proved extremely popular, is the consolidation of all the reports from a firm’s different custodians into one daily report. Without specialist systems to do this, a manager may not be able to automate a single report.

The value of predictability

In the wake of some of last year’s upheavals in the prime brokerage space, it’s clear that we’re undergoing a shakeup in the sector. That may not fundamentally alter the trend towards smaller clients in the bulge bracket segment, but it has changed the dynamics.

Ultimately, however, what many funds want most from their prime brokers is a blend of full service and predictability. They want to get on with their business without having to worry about a provider withdrawing from the sector, or pressure to meet certain thresholds, or finding their terms have changed suddenly.

At Cowen, we see predictability and stability as one of our biggest strengths. We’ve been around for more than 100 years. We’re fully regulated by the SEC and the FCA. We’re conservative in how we manage ourselves and our client relationships. So, for the funds we work with, that means they do not need to worry about sudden changes – at least not with us.


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