Brokering change

Every sector has its watershed moments. A time when the old is made redundant, lines are drawn in the sand and the new, searching dawn light arrives. For prime brokers, post-Lehman, it has been 18 months of dawn intrusions. A series of troubling wakings that started with client concerns over rehypothecation, matured with new custodial solutions, and ended with the challenging stipulations of the EU’s AIFM Directive and, now, President Obama’s proposed banking reforms.

While US banks must contend with the possibility that, depending on the interpretation of Paul Volcker’s intentions, they may no longer be able to even advise hedge funds, UK-based PBs are still mulling over a year-old UK Treasury document.
 

“Few managers even knew what rehypothecation was before this”, said fellow breakfast speaker Stephen Foster, Credit Suisse’s head of single manager funds. “Clearly, it’s all changed now.” Foster admits that he is now more hawkish when taking advice from a PB. He believes that others will judge their service provider depending on their behaviour throughout the crisis. “Managers will still take into account what happened to prime brokerage after Lehman; what happened to margining and financing conditions,” he says.  

Bob Sloane, the founder of S3 partners, a business that advises hedge funds on prime brokerage selection, agrees. “Hedge fund managers now understand that their business risk is a real one – this has become a competitive factor for the prime brokers in winning new hedge fund business. It’s also something that is equally driven by the investors.”
This sea change has been good news for custody businesses. And given the steady flow of business to custody banks over the past 12 months, the method of asset protection provided by prime brokers is as relevant as ever. According to a forthcoming Deutsche Bank investor survey, 60% of hedge fund investors said they would not allocate to funds that did not segregate assets.

While segregation is clearly a positive, not all forms are equal, as the survey’s findings go on to suggest. Special purpose vehicles, which Byrne rather disdainfully described as covering all of the “practical issues”, are deemed to be less attractive as internal solutions or external providers – which garnered a mighty 66%, compared to the single-digit approval ratings of the other two solutions.

And the opinion of investors matters more than ever. Prime brokers now have increased contact with the end allocator, according to Byrne, while Foster explains that investors do take more of an interest in prime brokerage relationships  – one of the reasons why bank owned custody-providers, Deutsche and Credit Suisse in particular, have enjoyed a golden 12 months of business development.

This growth is also due, in part, to a greater emphasis on multiple prime relationships, says Foster. Not all buy into this, citing multi-prime relationships as a sop for investors and a convenient cloak for one real PB and a 'dummy' account. Sloane says, “multiple prime is happening, but not at the frequency that some would expect. When you have more than one prime broker for a single fund, how can you track the data? You’ll need to cohere and ‘normalise’ all of the prime brokers’ reports and this isn’t necessarily easy.”

If multiple prime still has some way to go, custody solutions are as immediate as tomorrow’s dawn. For those prime brokers who can assure funds that they can get the segregation of assets right, the future also looks bright,
as the industry, in 2010, anticipates continuing demand, a changing market and the popularity of new vehicles, like Ucits III.