08/09/2010 Author: Tony Griffiths

Prime climate

In order to chart the pace of change in the prime brokerage space, HFMWeek spoke to an emerging name in the sector, HSBC, along with an industry stalwart, Deutsche Bank

Never has the prime brokerage space been so alive with activity or packed with participants. With the Morgan-Goldman duopoly now a moribund concept, all manner of fresh business is up for grabs and a mixture of new and established players are busy positioning themselves for growth.     

The challenge facing the emerging prime broker, however, is of a different nature to that with which the established player is tasked. Both will be required to meet the same demands – custody and capital-raising being two key issues currently – in the same uncertain clime, but will do so from differing starting points and, therefore, with differing tools and experience.

HFMWeek spoke to two big names in the world of hedge funds: one, Deutsche Bank, an established force in prime brokerage; and the other, HSBC, an emerging force. A continuation of recent success is top of the agenda for Deutsche Bank, while at HSBC, a stalwart of hedge funds but a freshman to prime services, the reproduction of success elsewhere is the first step along the road.

THE EMERGING FORCE: HSBC

HSBC, one of the few big names without a prime brokerage offering during the post-Lehman chaos, has finally thrown its hat into the ring. After a year-long development, the banking giant is rolling out a prime services capability to its European clients, entering a market only just returning to relative stability after months of internal competition.  
The division’s head, Cian Burke, however, is quick to qualify, if not quash altogether, the notion of HSBC as a novice within the space. An emerging force in prime brokerage the bank may be, he says, but, the firm has been dealing with hedge funds via various parts of the HSBC group for a number of years. “We’re by no means a newcomer to hedge funds,” he asserts.

Apart from aiding a range of hedge fund investors through its established private banking division, HSBC is one of the world’s largest managers of fund of hedge funds (FoHF) assets, overseeing $23bn, while its custody arm – one of the biggest beneficiaries of the post-Lehman flight to quality – currently holds over $10bn in hedge fund assets.

It was rumblings from within HSBC’s swelling custody division that proved the catalyst for the move into prime. Impressed with the bank’s Custody Plus offering – an additional service which allowed for the transparent segregation of assets coupled with an ability to provide finance and leverage over those assets – HSBC’s recently acquired custody clients began enquiring after prime services.    

“It’s fair to say that it has been client driven,” admits Chris Barrow, who is heading up the growing HSBC prime services sales force. “There was a desire among investors and clients to have a prime services provider that could offer them leverage without transferring the title of their assets.”

“The whole prime proposition was about taking what we’d built in Custody Plus and wrapping around that a broader prime services proposition,” Burke explains. “There’s a lot of what we do in the hedge fund space which, to all intents and purposes, is the beginnings of a prime services proposition as it is – we have a significant OTC business, we have global execution capabilities, we provide funding and equity financing and we have Custody Plus. That led to some strategic thinking about what we can deliver.”

Having submitted a proposition to the HSBC directors in early 2009, Burke was given the go-ahead to launch and run a fully fledged HSBC prime brokerage offering in August of that year. Burke launched a programme for change in January 2010 and has spent the rest of the year piecing together the elements required and building a team capable of doing them justice.

There are over 130 people developing the platform and around 30 people in UK and 10 or so in Asia supporting the new business being taken on. Several additions have been made in recent months and more are expected, mainly in the client services, risk and colleteral management teams. Two areas in which hires are less likely are PB-specific consultancy and cap intro. In both cases Burke intends to leverage expertise from HSBC’s existing personnel.   
“Our initial momentum is going to be gained by being in a multi-prime brokerage environment and from those funds with which we currently have an ongoing and existing relationship,” explains Burke. “You want to try and build and leverage the relationships that you’ve got.”

Burke and Barrow may point to Custody Plus as the magnet for business, but, in an industry in which increasingly cramped participants are looking to stretch their legs, HSBC has, quite literally, more room for manoeuvre than most.    

“If you look from a macro economic perspective, it’s undeniable that the global macro economy is increasingly shifting West to East, and if you’re looking at future opportunities there has to be an increased opportunity in some of those emerging markets,” Burke says. “Anyone can execute in an emerging market but do they have the ability to provide detailed, on-the-ground coverage in those emerging markets? No, I don’t think there are a great number of people who can. It is our footprint and pure coverage that plays to our strengths. Our go-to proposition was about building and developing capabilities in Europe

because that’s where we have the existing Custody and Custody Plus propositions. However, if our brand is strong here in Europe, it’s extremely strong in Asia. There’s a very interesting opportunity that we’re now pursing very aggressively in Asia – we’re building and delivering in Europe, while building and delivering in parallel in Asia.”
And it’s not just the Far East that is ready-made for HSBC expansion. The bank may have a 70% share of the domestic fund administration market for alternatives in Asia, but is also a dominant sub-custodian, domestically and cross-border, both in Asia and the Middle East. Latin America is similarly well represented. Brazil, whose maturing hedge fund industry has been subject to a growing amount of attention from primes in recent months, most notably from Morgan Stanley, is already home to an HSBC custody and fund administration offering, with other capabilities also available. Burke expects to be able to offer a prime services capability for Latin America by late-2011.

Though dominant in Asia, the Middle East and Brazil, HSBC representation in the US is still to take off, meaning Burke’s plans for a US prime brokerage are, perhaps unsurprisingly, somewhat less certain. “You ignore the US at your peril,” he says. “But we have to be clear on what it means for us. While I think we’ve got a huge opportunity to talk to US fund managers about where they want to invest internationally, in emerging markets, honestly, we do have some limitations in terms of our US domestic execution and custody capabilities.”

Regardless of how US plans progress, Burke’s plate is well and truly full, with a range of emerging markets due to follow Europe in hosting prime brokerage offerings. HSBC may be a relative latecomer to the PB space, but with a global footprint larger than many of its more established peers, ground may prove quick to be gained.

THE ESTABLISHED FORCE: DEUTSCHE BANK
An established name in the prime brokerage sector, Deutsche Bank has achieved the kind of industry standing emerging primes are looking replicate. Where once there was clear daylight between a duopoly – Morgan Stanley and Goldman Sachs – and the second tier, Deutsche among them, there is now a far more even keel, with little in terms of pure business to distinguish between the top five.

Of course, much of this is owed to the mandate merry-go-round that followed the collapse of Lehman Brothers, wherein the likes of Deutsche Bank – a strong European brand with deep pockets to boot – benefited from a flood of managers redistributing assets from the ‘Big Two’ to those secondary primes considered safe. Its current challenge, therefore, is less one of climbing the ladder and more of maintaining its lofty perch; of consolidating the business is has attained.  

“The flight to quality was towards providers with high quality infrastructure already in place,” says Danny Caplan, Deutsche Bank’s head of global prime finance sales, Europe. “Since then, and to ensure retention of that business, we have continued to invest heavily in key areas such as technology, product development, and business consultancy.”

The bank’s summer hiring spree has added to its consultancy ranks, but of primary concern has been the continued development of its custody offering. Deutsche was one of the first among the recent wave of tri-party custody initiatives – announcing a venture with custodian Bank of New York Mellon in December 2009 – and, with rivals quick to follow suit, is keen to avoid resting on its laurels. “Asset segregation is still a very significant issue in the choice of a PB and it is one of the areas that continues to be a focus for both us and our clients,” says Simon Kempton, Deutsche head of international prime brokerage.

“Not all asset segregation is the same,” adds Caplan. “The model we have is simple and robust. This approach has helped our clients to sign up quickly and has made it the solution of choice for many of the larger investor groups. Our goal is to set new industry benchmarks that will redefine the future prime brokerage model.”

Custody services – rapidly developing into a mark of overall prime service quality – have rarely experienced more scrutiny; from managers, investors and regulators alike. In search of these new “benchmarks”, Deutsche has made concerted efforts to prove its offering is, objectively, of the highest possible criterion, by achieving full compliance with US auditing principle Sas (Statement on Auditing Standards) 70.

An effective stamp of approval for a credit institution's control environment, a Sas70 is reviewed by an independent accounting firm – in Deutsche’s case PwC – in two stages: a Type I report that covers a review of the controls in place; and a Type II report; that encompasses a full and comprehensive testing of said controls. Kempton
believes that Deutsche is the first PB to secure a Sas70 for its European PB business, including asset segregation.  
“Deutsche were early movers on the Sas70 within the prime brokerage community,” he says. “We believe that other PBs are now beginning to follow suit and we are also seeing a number of the major hedge funds embarking on their own Sas70s. It’s becoming a much more important part of the industry landscape, with clients frequently making enquiries on this topic.”

Full compliance with Sas70 – in parallel with continued efforts with manpower and technology – may prove a drop in the ocean in the grand timeline of prime brokerage competition, but it is likely to be successions of small yet significant victories such as these that see the sector’s established names retain the business that secured them their stripes.

HSBC, one of the few big names without a prime brokerage offering during the post-Lehman chaos, has finally thrown its hat into the ring. After a year-long development, the banking giant is rolling out a prime services capability to its European clients, entering a market only just returning to relative stability after months of internal competition.  
The division’s head, Cian Burke, however, is quick to qualify, if not quash altogether, the notion of HSBC as a novice within the space. An emerging force in prime brokerage the bank may be, he says, but, the firm has been dealing with hedge funds via various parts of the HSBC group for a number of years. “We’re by no means a newcomer to hedge funds,” he asserts.
Apart from aiding a range of hedge fund investors through its established private banking division, HSBC is one of the world’s largest managers of fund of hedge funds (FoHF) assets, overseeing $23bn, while its custody arm – one of the biggest beneficiaries of the post-Lehman flight to quality – currently holds over $10bn in hedge fund assets.
It was rumblings from within HSBC’s swelling custody division that proved the catalyst for the move into prime. Impressed with the bank’s Custody Plus offering – an additional service which allowed for the transparent segregation of assets coupled with an ability to provide finance and leverage over those assets – HSBC’s recently acquired custody clients began enquiring after prime services.    
“It’s fair to say that it has been client driven,” admits Chris Barrow, who is heading up the growing HSBC prime services sales force. “There was a desire among investors and clients to have a prime services provider that could offer them leverage without transferring the title of their assets.”
“The whole prime proposition was about taking what we’d built in Custody Plus and wrapping around that a broader prime services proposition,” Burke explains. “There’s a lot of what we do in the hedge fund space which, to all intents and purposes, is the beginnings of a prime services proposition as it is – we have a significant OTC business, we have global execution capabilities, we provide funding and equity financing and we have Custody Plus. That led to some strategic thinking about what we can deliver.”
Having submitted a proposition to the HSBC directors in early 2009, Burke was given the go-ahead to launch and run a fully fledged HSBC prime brokerage offering in August of that year. Burke launched a programme for change in January 2010 and has spent the rest of the year piecing together the elements required and building a team capable of doing them justice.
There are over 130 people developing the platform and around 30 people in UK and 10 or so in Asia supporting the new business being taken on. Several additions have been made in recent months and more are expected, mainly in the client services, risk and colleteral management teams. Two areas in which hires are less likely are PB-specific consultancy and cap intro. In both cases Burke intends to leverage expertise from HSBC’s existing personnel.   
“Our initial momentum is going to be gained by being in a multi-prime brokerage environment and from those funds with which we currently have an ongoing and existing relationship,” explains Burke. “You want to try and build and leverage the relationships that you’ve got.”
Burke and Barrow may point to Custody Plus as the magnet for business, but, in an industry in which increasingly cramped participants are looking to stretch their legs, HSBC has, quite literally, more room for manoeuvre than most.    
“If you look from a macro economic perspective, it’s undeniable that the global macro economy is increasingly shifting West to East, and if you’re looking at future opportunities there has to be an increased opportunity in some of those emerging markets,” Burke says. “Anyone can execute in an emerging market but do they have the ability to provide detailed, on-the-ground coverage in those emerging markets? No, I don’t think there are a great number of people who can. It is our footprint and pure coverage that plays to our strengths. Our go-to proposition was about building and developing capabilities in Europe
because that’s where we have the existing Custody and Custody Plus propositions. However, if our brand is strong here in Europe, it’s extremely strong in Asia. There’s a very interesting opportunity that we’re now pursing very aggressively in Asia – we’re building and delivering in Europe, while building and delivering in parallel in Asia.”
And it’s not just the Far East that is ready-made for HSBC expansion. The bank may have a 70% share of the domestic fund administration market for alternatives in Asia, but is also a dominant sub-custodian, domestically and cross-border, both in Asia and the Middle East. Latin America is similarly well represented. Brazil, whose maturing hedge fund industry has been subject to a growing amount of attention from primes in recent months, most notably from Morgan Stanley, is already home to an HSBC custody and fund administration offering, with other capabilities also available. Burke expects to be able to offer a prime services capability for Latin America by late-2011.
Though dominant in Asia, the Middle East and Brazil, HSBC representation in the US is still to take off, meaning Burke’s plans for a US prime brokerage are, perhaps unsurprisingly, somewhat less certain. “You ignore the US at your peril,” he says. “But we have to be clear on what it means for us. While I think we’ve got a huge opportunity to talk to US fund managers about where they want to invest internationally, in emerging markets, honestly, we do have some limitations in terms of our US domestic execution and custody capabilities.”
Regardless of how US plans progress, Burke’s plate is well and truly full, with a range of emerging markets due to follow Europe in hosting prime brokerage offerings. HSBC may be a relative latecomer to the PB space, but with a global footprint larger than many of its more established peers, ground may prove quick to be gained