Prime Brokerage Business

Prime Brokerage Business | Wikipedia

Quick Link: Hedge Fund Prime Brokers

Prime brokerage is the generic name for a bundled package of services offered by investment banks and securities firms to hedge funds and other professional investors needing the ability to borrow securities and cash to be able to invest on a leveraged basis and achieve an absolute return. The business advantage to a hedge fund of using a Prime Broker is that the Prime Broker provides a centralized securities clearing facility for the hedge fund, and the hedge fund’s collateral requirements are netted across all deals handled by the Prime Broker. The Prime Broker benefits by earning fees (“spreads”) on financing the client’s long and short cash and security positions, and by charging, in some cases, fees for clearing and/or other services. It also earns money by hypothecating the portfolios of the hedge funds it services and charging a fee to those borrowing securities and other investments.

The following services are typically bundled into the Prime Brokerage package:

• global custody (including clearing, custody, and asset servicing)
• Securities lending
• Financing (to facilitate leverage of client assets)
• Customized Technology (provide hedge fund managers with portfolio reporting needed to effectively manage money)
• Operational Support (prime brokers act as a hedge fund’s primary operations contact with all other broker dealers)

In addition, certain prime brokers provide additional “value-added” services, which may include some or all of the following:

• Capital Introduction – A process whereby the prime broker attempts to introduce its hedge fund clients to qualified hedge fund investors who have an interest in exploring new opportunities to make hedge fund investments.
• Office Space Leasing and Servicing – Certain prime brokers lease commercial real estate, and then sublease blocks of space to hedge fund tenants. These prime brokers typically provide a suite of on-site services for clients who utilize their space.
• Risk Management Advisory Services – The provision of risk analytic technology, sometimes supplemented by consulting by senior risk professionals.
• Consulting Services – A range of consulting / advisory services, typically provided to “start-up” hedge funds, and focused on issues associated with regulatory establishment requirements in the jurisdiction where the hedge fund manager will be resident, as well as in the jurisdiction(s) where the fund itself will be domiciled.

History

The basic services offered by a prime broker give a money manager the ability to trade with multiple brokerage houses while maintaining, in a centralized master account at their prime broker, all of the hedge fund’s cash and securities. Additionally, the prime broker offers stock loan services, portfolio reporting, consolidated cash management and other services. Fundamentally, the advent of the Prime Broker freed the money manager from the more time consuming and expensive aspects of running a fund. These services worked because they also allowed the money manager to maintain relationships with multiple brokerage houses for IPO allocations, research, best execution, conference access and other products.

The concept and term “prime brokerage” is generally attributed to the U.S. broker-dealer Furman Selz in the late 1970s. However, the first hedge fund operation is attributed to Alfred Winslow Jones in 1949. In the pre-prime brokerage marketplace, portfolio management was a significant challenge; money managers had to keep track of all of their own trades, consolidate their positions and calculate their performance regardless of which brokerage firms executed those trades or maintained those positions. The concept was immediately seen to be successful, and was quickly copied by the dominant bulge bracket brokerage firms such as Morgan Stanley, Bear Stearns, Merrill Lynch, Lehman Brothers, and Goldman Sachs. At this nascent stage, hedge funds were much smaller than they are today and were mostly U.S. domestic long-short equities funds. The first non-U.S. prime brokerage business was created by Merrill Lynch’s London office in the late 1980s.

Through the 1980s and 1990s, prime brokerage was largely an equities-based product, although various prime brokers did supplement their core equities capabilities with basic bond clearing and custody. In addition, prime brokers supplemented their operational function by providing portfolio reporting; initially by messenger, then by fax and today over the web. Over the years, prime brokers have expanded their product and service offerings to include some or all of the full range of fixed income and derivative products, as well as foreign exchange and futures products.

As hedge funds have proliferated globally through the 1990s and the current decade, prime brokerage has become an increasingly competitive field and an important contributor to the overall profitability of the investment banking business. As of 2006, the most successful investment banks each report over two billion dollars in annual revenue directly attributed to their prime brokerage operations (source: 2006 annual reports of Morgan Stanley and Goldman Sachs).

Fees

Prime brokers do not charge a fee for the bundled package of services they provide to hedge funds. Rather, revenues are typically derived from three sources: spreads on financing (including stock loan), trading commissions and fees for the settlement of transactions done away from the prime broker. The financing and lending spreads, which are charged in basis points on the value of client loans (debit balances), client deposits (credit balances), client short sales (short balances), and synthetic financing products such as swaps and CFDs (Contract for difference), make up the vast majority of prime brokerage revenue. Therefore, clients who undertake substantial short-selling or leverage represent more lucrative opportunity than clients who do relatively less short selling and/or utilize minimal leverage. Clients whose market activities are principally fixed income oriented will generally produce less prime brokerage revenue, but may still present significant economic opportunity in the repo, foreign exchange (fx), futures, and flow business areas of the investment bank.

Risks

Prime Brokers facilitate hedge fund leverage, primarily through loans secured by the long positions of their clients. In this regard, the Prime Broker is exposed to the risk of loss in the event that the value of collateral held as security declines below the loan value, and the client is unable to repay the deficit. In practice, such conditions arise only in the case of extraordinary volatility or unexpected correlation reversions and are exceedingly rare. Other forms of risk inherent in Prime Brokerage include operational risk and reputational risk.

Large prime brokerage firms today typically monitor the risk within client portfolios by either Value at Risk (VaR) or “Rules Based” stress testing. Stress testing entails running a series of what-if scenarios that identify the potential gains or losses for each position due to adverse market events.

Examples of stress test scenarios include:

* Flight to Quality
* 1% up or down parallel movement in 10 year treasury yield curve

Retrieved from Wikipedia

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Prime Brokerage News

Prime Brokerage News | Large Banks Win Business

(PrimeBrokerageGuide.com) Recently hedge funds have been moving some assets away from investment banks which specialize in providing a relatively narrow number of products to broader diversified banks which are more secure in earn money in hundreds of different ways. These larger banks often make money by catering to both institutional and retail clients and are less likely to fail. Some of these firms to recently benefit have been BNP Paribas, Fidelity, Credit Suisse, and Deutsche Bank (view our list of prime brokers on the right hand side of PrimeBrokerageGuide.com).

As counterparty risk management and multi-prime bokerage both grow in popularity this trend will only increase. The list of top prime brokers by the end of 2009 could look very different than it did just this last year. Here is a recent article on this topic:

Broker-dealers such as Morgan Stanley and Goldman Sachs are losing out in the battle for hedge funds’ dwindling pool of assets, as funds seek out banks with diverse sources of funding in a major shake-up of prime broking.

The collapse of investment bank Lehman Brothers (LEHMQ.PK) in September shocked hedge funds, as those with accounts at Lehman when it sought bankruptcy protection had those assets frozen and risked being unable to close trades.

“The Lehman bankruptcy … led many hedge funds to flee the two largest prime brokers, Morgan Stanley and Goldman, for the perceived safety of the universal banks,” said BersteinResearch analyst Brad Hintz in a note.

Prime brokers make money by charging hedge funds fees for providing financing for trading and settlement of trades.

Credit Suisse (CSGN.VX), whose operations include a large wealth management unit as well as prime broking, saw balances in its prime brokerage unit grow 50-60 percent last year compared with 2007, a source familiar with the business said.

Roy Martins, the bank’s head of international prime services, said: “There was a peak in terms of business in September and October. All the clients we took on had existing relationships and dialogues with us as they were clients we had been targeting anyway.”

Deutsche Bank (DBKGn.DE), backed up by its big retail bank, has also benefited from an influx of business in its prime brokerage in the last six months, a source close to the bank said. source

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Prime Brokerage News

Prime Brokerage News | Large Banks Win Business

(HedgeFundBlogger.com) Recently hedge funds have been moving some assets away from investment banks which specialize in providing a relatively narrow number of products to placing their assets with broader diversified banks which are more secure in earn money in hundreds of different ways. These larger banks often make money by catering to both institutional and retail clients and have generally have lower percentage chances of failing.

Some of these firms to recently benefit have been BNP Paribas, Fidelity, Credit Suisse, and Deutsche Bank (view our list of prime brokers by clicking here).

As counterparty risk management and multi-prime bokerage both grow in popularity this trend will only increase. The list of top prime brokers by the end of 2009 could look very different than it did just this last year. Here is a recent article on this topic:

Broker-dealers such as Morgan Stanley and Goldman Sachs are losing out in the battle for hedge funds’ dwindling pool of assets, as funds seek out banks with diverse sources of funding in a major shake-up of prime broking.

The collapse of investment bank Lehman Brothers (LEHMQ.PK) in September shocked hedge funds, as those with accounts at Lehman when it sought bankruptcy protection had those assets frozen and risked being unable to close trades.

“The Lehman bankruptcy … led many hedge funds to flee the two largest prime brokers, Morgan Stanley and Goldman, for the perceived safety of the universal banks,” said BersteinResearch analyst Brad Hintz in a note.

Prime brokers make money by charging hedge funds fees for providing financing for trading and settlement of trades.

Credit Suisse (CSGN.VX), whose operations include a large wealth management unit as well as prime broking, saw balances in its prime brokerage unit grow 50-60 percent last year compared with 2007, a source familiar with the business said.

Roy Martins, the bank’s head of international prime services, said: “There was a peak in terms of business in September and October. All the clients we took on had existing relationships and dialogues with us as they were clients we had been targeting anyway.”

Deutsche Bank (DBKGn.DE), backed up by its big retail bank, has also benefited from an influx of business in its prime brokerage in the last six months, a source close to the bank said. source

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Prime Brokerage Training

Prime Brokerage Training | Prime Broker Resources

(PrimeBrokerageGuide.com) Several months ago I was building a list of hedge fund training resources. I send out a blog post on the topic and received over 40 additional groups which offered some type of hedge fund related training service. This was very helpful in building a list which would benefit everyone who visits this site, the list may be seen here: Hedge Fund Training.

The reason I’m writing this post today is that I’m looking for the top 10 resources for prime brokerage training. What are the top 10 ways a prime brokerage professional could re-invest in themselves and growth their career? Here is the start of a list:

1. Purchase the book Hedge Funds & Prime Brokers
2. Join 385 others and become a member of the the Prime Brokerage Association networking group here.
3. Attend conferences and events specifically on prime brokerage, trading and counter-party risk management (Anyone have a list of those groups who offer these?)
4. More ideas?

I would like to flush out this list so we that this site and PrimeBrokerageGuide.com can offer a full top 10 prime brokerage training options list. Thank you in advance for the help.

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Prime Brokerage Training

Prime Brokerage Training | Top 10 Resources

(HedgeFundBlogger.com) Several months ago I was building a list of hedge fund training resources. I send out a blog post on the topic and received over 40 additional groups which offered some type of hedge fund related training service. This was very helpful in building a list which would benefit everyone who visits this site, the list may be seen here: Hedge Fund Training.

The reason I’m writing this post today is that I’m looking for the top 10 resources for prime brokerage training. What are the top 10 ways a prime brokerage professional could re-invest in themselves and growth their career? Here is the start of a list:

1. Purchase the book Hedge Funds & Prime Brokers
2. Join 385 others and become a member of the the Prime Brokerage Association networking group here.
3. Attend conferences and events specifically on prime brokerage, trading and counter-party risk management (Anyone have a list of those groups who offer these?)
4. More ideas?

I would like to flush out this list so we that this site and PrimeBrokerageGuide.com can offer a full top 10 prime brokerage training options list. Thank you in advance for the help.

Related to Prime Brokerage Training | Prime Broker Resources

• Hedge Fund Prime Brokers
• Prime Brokerage Services
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Prime Brokerage Business

Prime Brokerage Business | Wikipedia

Quick Link: Hedge Fund Prime Brokers

Prime brokerage is the generic name for a bundled package of services offered by investment banks and securities firms to hedge funds and other professional investors needing the ability to borrow securities and cash to be able to invest on a leveraged basis and achieve an absolute return. The business advantage to a hedge fund of using a Prime Broker is that the Prime Broker provides a centralized securities clearing facility for the hedge fund, and the hedge fund’s collateral requirements are netted across all deals handled by the Prime Broker. The Prime Broker benefits by earning fees (“spreads”) on financing the client’s long and short cash and security positions, and by charging, in some cases, fees for clearing and/or other services. It also earns money by hypothecating the portfolios of the hedge funds it services and charging a fee to those borrowing securities and other investments.

The following services are typically bundled into the Prime Brokerage package:

• global custody (including clearing, custody, and asset servicing)
• Securities lending
• Financing (to facilitate leverage of client assets)
• Customized Technology (provide hedge fund managers with portfolio reporting needed to effectively manage money)
• Operational Support (prime brokers act as a hedge fund’s primary operations contact with all other broker dealers)

In addition, certain prime brokers provide additional “value-added” services, which may include some or all of the following:

• Capital Introduction – A process whereby the prime broker attempts to introduce its hedge fund clients to qualified hedge fund investors who have an interest in exploring new opportunities to make hedge fund investments.
• Office Space Leasing and Servicing – Certain prime brokers lease commercial real estate, and then sublease blocks of space to hedge fund tenants. These prime brokers typically provide a suite of on-site services for clients who utilize their space.
• Risk Management Advisory Services – The provision of risk analytic technology, sometimes supplemented by consulting by senior risk professionals.
• Consulting Services – A range of consulting / advisory services, typically provided to “start-up” hedge funds, and focused on issues associated with regulatory establishment requirements in the jurisdiction where the hedge fund manager will be resident, as well as in the jurisdiction(s) where the fund itself will be domiciled.

History

The basic services offered by a prime broker give a money manager the ability to trade with multiple brokerage houses while maintaining, in a centralized master account at their prime broker, all of the hedge fund’s cash and securities. Additionally, the prime broker offers stock loan services, portfolio reporting, consolidated cash management and other services. Fundamentally, the advent of the Prime Broker freed the money manager from the more time consuming and expensive aspects of running a fund. These services worked because they also allowed the money manager to maintain relationships with multiple brokerage houses for IPO allocations, research, best execution, conference access and other products.

The concept and term “prime brokerage” is generally attributed to the U.S. broker-dealer Furman Selz in the late 1970s. However, the first hedge fund operation is attributed to Alfred Winslow Jones in 1949. In the pre-prime brokerage marketplace, portfolio management was a significant challenge; money managers had to keep track of all of their own trades, consolidate their positions and calculate their performance regardless of which brokerage firms executed those trades or maintained those positions. The concept was immediately seen to be successful, and was quickly copied by the dominant bulge bracket brokerage firms such as Morgan Stanley, Bear Stearns, Merrill Lynch, Lehman Brothers, and Goldman Sachs. At this nascent stage, hedge funds were much smaller than they are today and were mostly U.S. domestic long-short equities funds. The first non-U.S. prime brokerage business was created by Merrill Lynch’s London office in the late 1980s.

Through the 1980s and 1990s, prime brokerage was largely an equities-based product, although various prime brokers did supplement their core equities capabilities with basic bond clearing and custody. In addition, prime brokers supplemented their operational function by providing portfolio reporting; initially by messenger, then by fax and today over the web. Over the years, prime brokers have expanded their product and service offerings to include some or all of the full range of fixed income and derivative products, as well as foreign exchange and futures products.

As hedge funds have proliferated globally through the 1990s and the current decade, prime brokerage has become an increasingly competitive field and an important contributor to the overall profitability of the investment banking business. As of 2006, the most successful investment banks each report over two billion dollars in annual revenue directly attributed to their prime brokerage operations (source: 2006 annual reports of Morgan Stanley and Goldman Sachs).

Fees

Prime brokers do not charge a fee for the bundled package of services they provide to hedge funds. Rather, revenues are typically derived from three sources: spreads on financing (including stock loan), trading commissions and fees for the settlement of transactions done away from the prime broker. The financing and lending spreads, which are charged in basis points on the value of client loans (debit balances), client deposits (credit balances), client short sales (short balances), and synthetic financing products such as swaps and CFDs (Contract for difference), make up the vast majority of prime brokerage revenue. Therefore, clients who undertake substantial short-selling or leverage represent more lucrative opportunity than clients who do relatively less short selling and/or utilize minimal leverage. Clients whose market activities are principally fixed income oriented will generally produce less prime brokerage revenue, but may still present significant economic opportunity in the repo, foreign exchange (fx), futures, and flow business areas of the investment bank.

Risks

Prime Brokers facilitate hedge fund leverage, primarily through loans secured by the long positions of their clients. In this regard, the Prime Broker is exposed to the risk of loss in the event that the value of collateral held as security declines below the loan value, and the client is unable to repay the deficit. In practice, such conditions arise only in the case of extraordinary volatility or unexpected correlation reversions and are exceedingly rare. Other forms of risk inherent in Prime Brokerage include operational risk and reputational risk.

Large prime brokerage firms today typically monitor the risk within client portfolios by either Value at Risk (VaR) or “Rules Based” stress testing. Stress testing entails running a series of what-if scenarios that identify the potential gains or losses for each position due to adverse market events.

Examples of stress test scenarios include:

* Flight to Quality
* 1% up or down parallel movement in 10 year treasury yield curve

Retrieved from Wikipedia

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Adding a Second Prime Broker

Adding a Second Prime Broker

While looking for a client document online I found a white paper on prime brokerage which discusses the use of multi prime brokerage firms by a single hedge fund.

This white paper claims that the benefits of adding a second prime broker include:

• Mitigation of risk: counterparty, financing, liquidity and operational
• An additional source of alpha-generating trade ideas, capital
  introductions, etc.
• Ensure optimal financing through competitive pricing of
  margin lending and stock loan
• Gain access to competitive or innovative cross-margining
  policies of the competing prime broker
• Leverage across the relative strengths of service providers
  in synthetic financing, swap trading or market access
• Catalyst for reduced dependency on outside service
  providers, giving greater direct operational control

This full white paper may be read here. To contact prime brokerage firms who have helped support this website please see our service provider directory listing of them here: Prime Brokers

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Adding a Second Prime Broker

Adding a Second Prime Broker

While looking for a client document online I found a white paper on prime brokerage which discusses the use of multi prime brokerage firms by a single hedge fund.

This white paper claims that the benefits of adding a second prime broker include:

• Mitigation of risk: counterparty, financing, liquidity and operational
• An additional source of alpha-generating trade ideas, capital
  introductions, etc.
• Ensure optimal financing through competitive pricing of
  margin lending and stock loan
• Gain access to competitive or innovative cross-margining
  policies of the competing prime broker
• Leverage across the relative strengths of service providers
  in synthetic financing, swap trading or market access
• Catalyst for reduced dependency on outside service
  providers, giving greater direct operational control

This full white paper may be read here.

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Prime Brokerage Risk

Prime Brokerage Risk | Risks of Single Priming

Below is a short excerpt from an article I found on why hedge funds are now working with multiple prime brokers at one time. I believe this model will become even more important in 2009 and possibly become a required checkbox for investments from many institutional investors or a green light from institutional consultants.
___________________________________________

Why It’s Important: With the demise of Bear Stearns in March 2008 and the bankruptcy of Lehman Brothers this past September, hedge funds that had prime brokerage relationships with these firms were exposed to significant counterparty risk. Some hedge funds that primed with Lehman had their assets frozen as part of the European bankruptcy proceedings against Lehman, driving some to liquidate securities to meet redemption calls from investors and even forcing some out of business. “There are people who either had long assets on deposit and can’t get them back or, worse, Lehman borrowed the assets and lent them out,” explains Larry Tabb, founder and CEO of TABB Group.

Where the Industry Is Now: Most hedge funds with more than $250 million in assets have relationships with two to four primes, which are picked for their trading expertise in certain asset classes (e.g., FX or derivatives) or geographies, such as Europe or Asia. For smaller hedge funds, however, diversifying can be difficult because the large prime brokers have minimum-asset requirements and other constraints to weed out the smaller players. Smaller hedge funds, with $10 to $15 million in AUM, typically launch with a single prime broker that may provide trading systems, margin accounts, stock loans and clearing. source

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Prime Brokerage Risk

Prime Brokerage Risk | Risks of Single Priming

Below is a short excerpt from an article I found on why hedge funds are now working with multiple prime brokers at one time. I believe this model will become even more important in 2009 and possibly become a required checkbox for investments from many institutional investors or a green light from institutional consultants.
___________________________________________

Why It’s Important: With the demise of Bear Stearns in March 2008 and the bankruptcy of Lehman Brothers this past September, hedge funds that had prime brokerage relationships with these firms were exposed to significant counterparty risk. Some hedge funds that primed with Lehman had their assets frozen as part of the European bankruptcy proceedings against Lehman, driving some to liquidate securities to meet redemption calls from investors and even forcing some out of business. “There are people who either had long assets on deposit and can’t get them back or, worse, Lehman borrowed the assets and lent them out,” explains Larry Tabb, founder and CEO of TABB Group.

Where the Industry Is Now: Most hedge funds with more than $250 million in assets have relationships with two to four primes, which are picked for their trading expertise in certain asset classes (e.g., FX or derivatives) or geographies, such as Europe or Asia. For smaller hedge funds, however, diversifying can be difficult because the large prime brokers have minimum-asset requirements and other constraints to weed out the smaller players. Smaller hedge funds, with $10 to $15 million in AUM, typically launch with a single prime broker that may provide trading systems, margin accounts, stock loans and clearing. source

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Prime Brokerage Agreement

Prime Brokerage Agreement | Contract

While looking for a white paper on prime brokerage I stumbled upon an example prime brokerage services contract. If you are conducting due diligence on prime brokers or about to sign a contract with one it may make sense to look at this example contract just to get a sense of what to expect or negotiate.

To view the example prime brokerage agreement please click here.

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New Prime Brokerage Model

New Prime Brokerage Model Emerging

The credit crisis and the subject of counter party risk is proving to be the final nail in the coffin for the hedge fund industry’s single prime brokerage model. Funds of all sizes now demand multiple custodial relationships.

The problem the high-cost-structure leading prime brokerage firms now face is that without the assurance of the captive single prime model the economics of servicing smaller funds no longer makes sense. This reality combined with the primes’ decreased risk tolerance means that we are seeing a mass exodus away from the top-tier primes. Anecdotal evidence suggests that these primes are now in the process of weeding out clients that manage less than $100 million or that do not generate annual revenues of at least $250,000. We are also witnessing primes becoming more selective about what type of funds they are willing to service. Funds whose strategies involve less liquid securities and/or high leverage are now finding the bar set much higher.

This retrenchment by the leading prime brokers raises the obvious questions – Who will fill the void and offer prime services to the lower end of the market? Who will provide the financing, stock loan, technology infrastructure etc. necessary for smaller funds to generate alpha?

Before we answer this question let’s take a moment to think about why this smaller hedge fund segment is so key to the future success of the industry. It is no secret that size kills alpha. Many successful funds follow a familiar arc. They gain attention (and funds) by earning outsized returns, as they grow in size their primary strategy reaches capacity and they experience a leveling off of returns. If they are not lucky enough to find another successful strategy, returns will continue to suffer, capital will begin to flow out and ultimately investment talent will go in search of new opportunities. This regeneration process is vital to the health of the industry and for many investors, it is the promise of catching a smaller fund during this growth phase that motivates them to invest.

Historically the group charged with picking up the crumbs left by the leading primes was a group known as the mini-primes. This term is rapidly becoming obsolete as the mini-primes now find themselves expanding their offerings to attract the funds that have been displaced. Two important differences remain: 1 – The mini’s still use the clearing services of their larger prime broker brethren, and 2 – more importantly, their cost-structures evolved in a way that allows them to offer prime services profitably at this lower end of the market. Interestingly we are also seeing a number of new entrants to this expanded segment of the prime brokerage industry. These are for the most part more traditional brokers who see an opportunity to increase the stickiness of their execution services, as well to develop new revenue streams, by building out a prime brokerage offering.

Only time will tell who will be successful in this greatly altered landscape of prime brokerage. The winners will be the firms that understand that the new economics of prime brokerage demand a new industry infrastructure. This prime infrastructure will rely heavily on cost-effective technologies that can offer aggregated multi-prime reporting, as well as real-time views of critical data such as P&L and Risk, right to the desktop of the hedge fund. This restructuring of the prime model will ensure the health of the industry by continuing to offer a relatively low barrier of entry to the all important small hedge fund segment.

Article contributed by Peter Curley of Nirvana Solutions

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New Prime Brokerage Model

New Prime Brokerage Model Emerging

The credit crisis and the subject of counter party risk is proving to be the final nail in the coffin for the hedge fund industry’s single prime brokerage model. Funds of all sizes now demand multiple custodial relationships.

The problem the high-cost-structure leading prime brokerage firms now face is that without the assurance of the captive single prime model the economics of servicing smaller funds no longer makes sense. This reality combined with the primes’ decreased risk tolerance means that we are seeing a mass exodus away from the top-tier primes. Anecdotal evidence suggests that these primes are now in the process of weeding out clients that manage less than $100 million or that do not generate annual revenues of at least $250,000. We are also witnessing primes becoming more selective about what type of funds they are willing to service. Funds whose strategies involve less liquid securities and/or high leverage are now finding the bar set much higher.

This retrenchment by the leading prime brokers raises the obvious questions – Who will fill the void and offer prime services to the lower end of the market? Who will provide the financing, stock loan, technology infrastructure etc. necessary for smaller funds to generate alpha?

Before we answer this question let’s take a moment to think about why this smaller hedge fund segment is so key to the future success of the industry. It is no secret that size kills alpha. Many successful funds follow a familiar arc. They gain attention (and funds) by earning outsized returns, as they grow in size their primary strategy reaches capacity and they experience a leveling off of returns. If they are not lucky enough to find another successful strategy, returns will continue to suffer, capital will begin to flow out and ultimately investment talent will go in search of new opportunities. This regeneration process is vital to the health of the industry and for many investors, it is the promise of catching a smaller fund during this growth phase that motivates them to invest.

Historically the group charged with picking up the crumbs left by the leading primes was a group known as the mini-primes. This term is rapidly becoming obsolete as the mini-primes now find themselves expanding their offerings to attract the funds that have been displaced. Two important differences remain: 1 – The mini’s still use the clearing services of their larger prime broker brethren, and 2 – more importantly, their cost-structures evolved in a way that allows them to offer prime services profitably at this lower end of the market. Interestingly we are also seeing a number of new entrants to this expanded segment of the prime brokerage industry. These are for the most part more traditional brokers who see an opportunity to increase the stickiness of their execution services, as well to develop new revenue streams, by building out a prime brokerage offering.

Only time will tell who will be successful in this greatly altered landscape of prime brokerage. The winners will be the firms that understand that the new economics of prime brokerage demand a new industry infrastructure. This prime infrastructure will rely heavily on cost-effective technologies that can offer aggregated multi-prime reporting, as well as real-time views of critical data such as P&L and Risk, right to the desktop of the hedge fund. This restructuring of the prime model will ensure the health of the industry by continuing to offer a relatively low barrier of entry to the all important small hedge fund segment.

Article contributed by Peter Curley of Nirvana Solutions

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Top 3 Trends

Top 3 Prime Brokerage Trends

Over the last two years the mainstream media’s and general public’s interest in prime brokerage has rapidly grown. This is due to a number of factors including the struggle and failure many investment banks(Lehman Brothers), mergers within the industry, and widespread failures and redemption notices from hedge funds.

The top three trends affecting the prime brokerage industry right now are multi-prime brokerage relationships, limiting capital introduction services, and prime brokers acting as business partners to hedge fund managers.

In the past, multi-prime brokerage relationships were used mostly by $5B+ hedge funds whose large institutional clients demanded the practice as a risk management technique. This was considered unnecessary as no large investment banks offering prime services had collapsed. It was seen in the same light as a major economic superpower defaulting on their own investment notes. Events in 2008, changed everything, Lehman failed and many investment banks have struggled or sold off their prime brokerage services to other firms. This has lead to widespread migrations between prime brokerage service providers and a trend towards managing multi-prime brokerage relationships for funds with over $500M in assets or even lower. Some firms as small as $5M are choosing to work with more than one prime brokerage firm from the very start as a few firms have reported shutting down due to assets being locked up within Lehman Brothers when they collapsed earlier this year.

Another shift in the industry has been felt within the area of capital introduction services. Anyone offering these services lately has faced increased challenges of investors sitting on cash, poor market and overall industry performance along with increasingly frequent reports of hedge fund fraud. Prime brokerage firms are not effected by this, especially since they often take on and attempt to service more clients than most independent hedge fund marketers which are often referred to as third party marketers would. This had led to more selective capital introduction service offerings by prime brokerage firms and more frequent partnerships between prime brokerage firms and third party marketers in the industry.

The third major trend affecting the prime brokerage business is that more firms in the space are positioning themselves as business partners. This is due to the commoditized nature of the industry and high level of competition for new business. Prime brokerage firms are now publishing white papers, offering business/marketing plan startup tools and holding workshops and networking events to help hedge fund managers connect with additional business partners and investors.

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Top 3 Trends

Top 3 Prime Brokerage Trends

Over the last two years the mainstream media’s and general public’s interest in prime brokerage has rapidly grown. This is due to a number of factors including the struggle and failure many investment banks offering prime brokerage services including Lehman Brothers, mergers within the industry and widespread failures and redemption notices of hedge funds themselves.

The top three trends affecting the prime brokerage industry right now are multi-prime brokerage relationships, limiting capital introduction services, and prime brokers acting as business partners to hedge fund managers.

Multi-prime brokerage relationships used to be used by $5B+ hedge funds whose large institutional clients demanded the practice as a risk management technique. In the past this was almost though of as unnecessary as no large investment banks offering prime services had collapsed. It was seen in the same light as a major economic superpower defaulting on their own investment notes. This year, in 2008 everything has changed, Lehman failed and many investment banks have struggled or sold off their prime brokerage services to other firms. This has lead to widespread migrations between prime brokerage service providers and a trend towards managing multi-prime brokerage relationships for funds with over $500M in assets or even lower. Some firms as small as $5M are choosing to work with more than one prime brokerage firm from the very start as a few firms have reported shutting down due to assets being locked up within Lehman Brothers when they collapsed earlier this year.

Another shift in the industry has been felt within the area of capital introduction services. Anyone offering these services lately has faced increased challenges of investors sitting on cash, poor market and overall industry performance along with increasingly frequent reports of hedge fund fraud. Prime brokerage firms are no effected by this, especially since they often take on and attempt to service more clients than most independent hedge fund marketers which are often referred to as third party marketers would. This had led to more selective capital introduction service offerings by prime brokerage firms and more frequent partnerships between prime brokerage firms and third party marketers in the industry.

The third major trend affecting the prime brokerage business is that more firms in the space are positioning themselves as business partners. This is due to the commoditized nature of the industry and high level of competition for new business. Prime brokerage firms are now publishing white papers, offering business plan and marketing plan startup tools and holding workshops and networking events to help hedge fund managers connect with additional business partners and investors.

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Prime Brokerage Market Share

A Brief Overview of Industry Market Share

A good read titled “Battle of the Bulges” pointed out that competition for gaining prime brokerage market share is growing fiercer with more than $11 billion in expected hedge fund revenues in 2008, a 15% increase over 2006 (reported by TABB Group). The fight for market share is even more intense among the industry’s top players.

For years the prime brokerage industry has been dominated by three firms—Goldman Sachs, Morgan Stanley and Bear, which collectively owned about two-thirds of the market. As of year-end 2006, the Lipper HedgeWorld prime brokerage league table ranked Morgan Stanley first (with 23% of the market and $153 billion in assets), followed by Bear (21%, $136 billion), Goldman (18%, $119 billion), UBS (7%, $47 billion) and Credit Suisse (4%, $25 billion), in terms of market share based on assets.

As Bear collapsed in March 2008, and Morgan Stanley and Goldman Sachs struggle to maintain their dominance in the industry, other major financial services firms are stepping up their prime brokerage efforts, including JPMorgan Chase, Deutsche Bank, UBS, Credit Suisse and BNP Paribas. JPMorgan Chased was only ranked eighth in the Lipper survey with just a 2.3% market share, now it is given a quick entry into prime brokerage as long as Bear’s hedge fund clients are successfully locked down. BNP Paribas bought Bank of America’s equity prime brokerage division that was ranked the sixth-largest in the country by assets at the end of 2006 by Lipper HedgeWorld, thus was instantly made one of the largest prime brokers in the U.S.

The recent turbulence in the prime brokerage industry also accelerated the trend of hedge funds moving away from replying on just one prime broker. Traditionally hedges funds are unwilling to switch prime brokers or increase the number of their prime brokers (TABB report). As Michael Guarasci, partner at hedge fund Indus Capital Partners said, “We have long-standing relationship with our prime brokers, so if a new company wants to come in and do business with us, it may not get anywhere because we’re pretty happy with our service. It’s not easy to switch prime brokers.” (full article). Now more and more hedge funds are adding prime brokers to limit counterparty risk since the fall of Bear (ref). This created considerable opportunity for new players to enter or existing players to take a bigger piece of the market share, as pointed out in an article by Merrill Lynch: “The multi-prime broker environment overcoming the challenges and reaping the benefits” (download the pdf).

Interested in learning more about prime brokerage. Please checkout the new website – http://PrimeBrokerageGuide.com.

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Tags: Prime Brokerage Market Share, Prime brokerage rankings, prime brokerage market share figures, prime brokerage, trading, prime broker, prime brokers

Rehypothication Risks

Rehypothication Risks, Rights & Costs

Here is a short article about the Rehypothication by prime brokerage firms, the definition of it, the risks of prime brokers using the strategy, the rights of hedge funds who loose access to their assets and what happens to the cost of prime brokerage services when hedge funds request for their assets not to be rehypothicated.

Here is a short excerpt from the article:

The dangers for hedge funds of having their assets rehypothecated became painfully clear last week: $22bn of the $40bn held by Lehman’s European prime brokerage had been rehypothecated. Hedge funds trying to reclaim the rehypothecated assets have found themselves in the queue of general creditors, likely to get back only a proportion of their money.

Even those hedge funds which had insisted they did not want their assets rehypothecated – such as Amber and a small RAB Capital fund – face a long and potentially painful wait to get back securities held in segregated client accounts. PwC, administrators of Lehman’s London business, have told hedge funds it is likely to take months to calculate how much is due to whom, and to offset this against debts.

But it is rehypothecation which poses the biggest threat to hedge funds, and could lead to the biggest changes in the prime brokerage industry. The main prime brokers were almost completely self-funding, according to current and former executives, needing very little access to the balance sheet of their parent bank, thanks to hedge fund cash kept on deposit and the rehypothecation of assets.

Most of the cash has already gone, hedge fund managers say, shifted away from prime brokerages to banks regarded as safer. Take away rehypothecation, and banks will have to borrow at far more expensive rates in order to lend to hedge funds, pushing down their profitability and pushing up the cost of borrowing. Read more…

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The goal of PrimeBrokerageGuide.com is to help hedge fund managers and other interested parties become more knowledgeable about the prime brokerage business. Our goal is to help anyone interested in understanding long-term trends affecting prime brokerage.

Here are 10 of our most popular articles on prime brokerage:

1. What is Prime Brokerage?
2. Prime Brokerage New York
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4. Prime Brokerage Boston
5. Prime Brokerage Chicago
6. Prime Brokerage Clearance Services
7. Capital Introduction Team
8. Lehman Prime Brokerage Unit Sold
9. Capital Introductions
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BNP Paribas Prime Bokerage

BNP Paribas Prime Brokerage Services – Notes

Here are a collection of publicly available stories on BNP Paribas SA prime brokerage services:

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Resource #1: (11.16.08) BNP Paribas SA, France’s biggest bank, won prime brokerage business in Asia with hedge fund CQS (U.K.) LLP as it seeks to lure clients in the region from rivals.

The new contract with CQS, a London-based hedge fund manager that has an office in Hong Kong and oversees about $7.5 billion, adds to BNP Paribas’s existing relationships with major hedge funds in the region, according to Talbot Stark, global head of BNP Paribas hedge fund relationships. He declined to name other existing clients.

“We have prime brokerage relationships with three or four of the market leaders in Asia that are outperforming their peers and look to be longer-term survivors in the Asian hedge fund market,” Stark, 43, said in a telephone interview yesterday. “We’re in discussions with several other key players that are making decisions to change their prime brokerage providers and are seeking alternative providers that are established and committed to the region.”

Commercial banks such as BNP are seeking to win customers from established players in the hedge fund market after the collapse of Lehman Brothers Holdings Inc. and Bear Stearns Cos. rattled confidence in securities firms. Goldman Sachs Group Inc. and Morgan Stanley were ranked by a Westborough, Massachusetts- based Tabb Group LLC report in May as the two biggest prime brokers worldwide.

Prime brokerages offer hedge funds services such as clearing, custody, securities lending and financing for assets. They also introduce fund managers to investors. Source
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Resource #2: BNP Paribas SA, France’s biggest bank, said it got a “flood” of clients at its prime brokerage since Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15.

BNP Paribas expanded its services for hedge funds in June, when it bought Bank of America Corp.’s prime brokerage unit. The unit provides record-keeping, securities lending and secured financing to more than 500 hedge funds and has 320 employees, the company said.

“That acquisition now looks timely in these markets as people are in the middle of a flight to quality,” said Talbot Stark, global head of BNP Paribas hedge fund relationships, in an interview today. “Foremost on people’s minds is ensuring that wherever they decide to put assets, they will be secure.”

Lehman won’t return “billions” of frozen prime-brokerage assets “in the short term,” Stephen Pearson, a partner at PricewaterhouseCoopers, administrator for the Lehman bankruptcy, said yesterday. GLG Partners Inc., the $24 billion hedge fund that started as a unit of Lehman 13 years ago, this week said some “residual” trades with Lehman didn’t clear before it filed the biggest bankruptcy in history.

While Stark wouldn’t specify how much money hedge funds have moved to BNP Paribas, he said the company is now taking only 24 hours to sign complex prime brokerage agreements that used to take as long as three months to negotiate. Read more…

_____________________

Resource #3:

The FINANCIAL — BNP Paribas is pleased to announce it has completed the acquisition of Bank of America’s equity prime brokerage business.

The equity prime brokerage business rovides a wide range of services to hedge funds and mutual funds. We believe it is a low risk, low capital consumption, service oriented business.

The deal, announced on June 10 of this year, brings more than 500 clients and over 300 employees to BNP Paribas Corporate and Investment Banking. The transaction involves the transfer of client relationships, employees and technology systems.

Yann Gerardin, Global Head of Equity and Commodity Derivatives, said: “The strategic fit of this acquisition is excellent. Combining the Bank of America prime brokerage business with our global platform and leading derivatives business creates a prime brokerage business of choice. It is an important advantage for clients to partner with a bank like BNP Paribas , with a AA+ credit rating and global reach”.

Todd Steinberg, Head of Equity and Commodity Derivatives for the Americas, said: “We are thrilled the deal has closed on schedule. Our goal was to move the business over seamlessly for clients and employees and we have achieved this. “

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Prime Broker Survey

Prime Broker Survey Results

A new survey shows that more than one-third of hedge fund and CTA managers are dissatisfied with their prime brokers. The most notable dissatisfaction is with the prime brokers’ personal service. In 2007 80% of funds rated the personal service of their prime brokers as either “good” or “excellent”, this year only 63% gave their prime brokers high marks. This may be a result of the liquidity crisis, which 16% of the managers said negatively effected the relationship with their prime broker.

The survey also shows that many funds are happy with the cost of their prime brokers, with only 7% responding “poor”. However, a considerable 38% of managers rating their prime brokers as “poor” performers of capital introduction. Funds who consider themselves technologically advanced are the most satisfied with their prime brokers.

Permanent Link: Prime Broker Survey Results

Tags: Prime Broker, Prime Broker Survey Results, Prime Brokerage Survey Results

Below are a series of resources related to Morgan Stanley’s Prime Brokerage business source

Resource #1: (7.5.09) What are Morgan Stanley’s intentions in the prime brokerage model? Well, fairly or not, the perception has developed as of late that it was seeking a new business model that relied less on leverage and anything seen as risky. Many assumed it wanted to ratchet back in prime brokerage, after having long ruled the roost with Goldman Sachs, but that may not be true. source

Resource #2 (5.22.09) Morgan Stanley replaced its top prime-brokerage official, underscoring big changes in the way investment banks are serving hedge-fund clients.

Stuart Hendel, who managed the New York firm’s prime-brokerage business since 2007, “has decided to leave the firm to pursue outside interests,” according to an internal memo released by Morgan Stanley on Thursday.

Mr. Hendel is being succeeded by Alex Ehrlich, who had been global head of prime services at UBS AG for the past six years. source

Resource #3: (4.3.09) U.S. prime brokerage business, Patrick Mortimer, resigned this week, The Wall Street Journal reported Wednesday. Mortimer left for personal reasons and no direct replacement is planned, according to the newspaper, which sourced people familiar with the matter

Resource #4: (11.17.08) Kurt Baker, the head of Morgan Stanley’s (MS) prime brokerage in Asia, is leaving the firm, a company spokesman confirmed Wednesday, but declined to comment further.
Baker’s departure comes a week after Morgan Stanley confirmed additional worldwide job cuts. It said it would reduce 10% of its staff in institutional securities, which includes prime brokerage, as well as 9% in asset management, which manages mutual funds and other investment instruments.

The firm has already cut about 10% of its work force this year. Since June 2007, the bank has cut around 4,500 employees, bringing its total staff to about 46,500 as of Aug. 31, 2008.
Morgan Stanley’s prime brokerage, one of the two largest in the Asia, has been hurt by a worldwide hedge-fund slump.

The hedge-fund industry has been struggling against trailing performance and a rising tide of redemptions. In Asia, the hedge-fund industry has been especially vulnerable to a focus on stocks and a tendency to go long. The Eurekahedge Asian Hedge Fund Index is down 21.6% so far this year.

Morgan Stanley’s prime brokerage operations, in particular, were hit after Lehman Brothers Holdings Inc. filed for bankruptcy protection in mid-September. Concerns about the stability of investment banks caused some hedge-fund clients to move assets. Source
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Resource #5: Stu Hendel will rejoin the Firm as Global Head of Prime Brokerage. He will be based in New York and report to Rich Portogallo, Head of the U.S. Equity Division and Global Equity Financing Services.

In this role, Mr. Hendel, 48, will oversee the Firm’s global prime brokerage business focusing on growing Morgan Stanley’s market leading franchise and meeting the evolving needs of clients. Mr. Hendel will also work closely with senior management in the Equities and Fixed Income divisions on defining and executing strategic direction for the group.

“We are delighted that Stu Hendel has chosen to return to Morgan Stanley,” said Jerker Johansson, Global Head of Equities and Co-Head of Institutional Sales and Trading at Morgan Stanley. “Stu had been instrumental in helping to build our prime brokerage business into the recognized market leader today. His experience and skill make him perfectly suited to continue our momentum in this business.”

Mr. Hendel rejoins Morgan Stanley from Eton Park, where he served as the Chief Operating Officer since that firm was organized in 2004.

“Stu’s innovation, content, passion and recent experience at one of the world’s most respected alternative investment firms will only further serve to reinforce our commitment to our clients and our staff,” said Rich Portogallo. “We are thrilled to have him back.”

Prior to joining Eton Park, Mr. Hendel spent 15 years at Morgan Stanley. He held a number of senior management positions in Prime Brokerage from 1993 to 2004, most recently serving as Co-Head of U.S. Prime Brokerage. Prior to that, Mr. Hendel worked in the legal division of Morgan Stanley from 1989 to 1993. Mr. Hendel received his J.D. from Cornell Law School 1983 where he served as business manager of the Law Review. He graduated from Wesleyan University in 1980. Mr. Hendel will rejoin Morgan Stanley in early 2007.

Tags: Morgan Stanley Prime Broker, Morgan Stanley Prime Brokerage Services, Prime Brokerage Services by Morgan Stanely

CHP Designation

Certified Hedge Fund Professional (CHP) Designation

Last week the Hedge Fund Group (HFG) began to offer the Certified Hedge Fund Professional (CHP). The CHP Program is a two part designation. Level 1 ensures that participants have mastered a broad foundation of hedge fund industry knowledge across 6 learning modules. Level 2 allows participants to specialize in a niche area of their choice such as due diligence, prime brokerage or marketing, sales and investor relations. The program is now open for registration to 100 participants after which point it will close to new entrants for 6 months while the website and FAQ related resources are improved.

To learn more about the Certified Hedge Fund Professional (CHP) designation please see the following links:

• CHP Frequently Asked Questions Guide
  
• CHP Study Guide
  
• CHP Program Overview
• CHP Program Registration

The Hedge Fund Group (HFG) has recently passed the 9,000 member mark and while we continue to be tied to the Linkedin.com platform we are beginning to plan on-site networking events this winter and hope to add 50 additional hedge funds to our board of advisers over the next year. As always HFG membership is free, sign up today at http://hedgefundgroup.org.

FINRA Broker Check

FINRA Broker Background Check Tool

Completing due diligence on a registered broker in the hedge fund industry?

FINRA offers investors a free online background check service of FINRA-registered securities firms and brokers. The FINRA BrokerCheck includes search capabilities for both a broker and brokerage firm, online delivery of the report, an explanation to help investors understand the information provided, and links to additional resources. BrokerCheck provides background information on an estimated 677,00 currently registered brokers and almost 5,000 currently registered securities firms. Also listed is an online collection of information about Investment Adviser firms that are regulated by the Securities and Exchange Commission.

- Richard

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What is Prime Brokerage?

Prime Brokerage Video Explanation

Here is a short video explaining what prime brokerage is, why it is important and how hedge funds rely on prime brokers to conduct day-to-day trading and reporting.

Permanent Link: What is Prime Brokerage?
Tags: Prime Brokerage, Prime Brokers, Prime Broker, Hedge Funds, Hedge Fund, Fund of Funds, Fund of Fund, Investment Funds, High Net Worth, What is prime prime brokerage, what are prime brokers, what is a prime broker

This leaves prime brokerage firms with two choices – offer capital introduction services knowing that there is almost no chance of raising assets or tell the hedge fund manager that they will not be able to market their strategy. The best prime brokers will often help with pre-marketing activities such as operational and risk assessments, marketing material scrubbing, newsletter development, etc.

This may seem straightforward but it is often an unsaid thorn in the side of prime brokerage firms offering capital introductions for hedge fund managers. They want to provide this service to everyone possible but by nature only 10-25% of all clients really qualify for the service.

Permanent Link: Capital Introductions
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