If the prime broker-hedge fund manager relationship has always been a numbers game, it is only recently that the players have started talking openly about the rules. Economic forces have seen subject matters that were previously taboo – such as revenue hurdles and fees – become formal discussion points during meetings, giving client-prime interaction a more ‘business-like’ feel. Profits are king, and all but the most impressive courtiers are feeling the pressure to perform.
But the new status quo is also working in the client’s favour. Bank-owned primes may be confident enough in their balance sheets to take bets on smaller clients again, but they are not in a position to shun profitable business. As prime brokers ramp up their search for the star clients of tomorrow, many hedge funds are benefiting already. Funds trading balance-sheet-friendly AuM are splitting their core business between multiple ‘tier one’ providers, winning fee concessions by creating service rankings and applying pressure accordingly. Fee transparency introduced under Mifid II may actually give managers more ammunition.
Mini primes may have enjoyed an uptick in business, and the quality of prime services generally may have improved, but developments have by no means diminished the importance of having a ‘tier one’ vendor. And, here, JP Morgan is providing some much-needed competition. The US bank is succeeding where Credit Suisse has thus far failed – eating into the revenue and US market share of the historical duopoly in a meaningful way, and offering a credible ‘tier one’ alternative for core services. This is good news for managers. A genuine three-way tussle at the top will mean more negotiating power for funds looking to put pressure on their top-tier primes.
If JP Morgan does establish itself as part of a triopoly, it will help crystallise a new industry hierarchy, one that is more forgiving of fund than prime. Lower-tier managers may be welcomed by higher-tier primes, but, with some of the sentiment drained from the client-prime relationship, lower-tier primes will struggle to attract higher-tier new clients or prevent clients from leaving as they grow. Ultimately, client perks are being replaced by service transparency – and that is something all serious managers can get on board with.
Exhibits and Citations
Section 1 – Sources of Tension
Exhibit 1.1: Timeline of key events in prime brokerage industry, 2011-2017, HFM Insights (Page 8)
Exhibit 1.2: Split and sole prime brokerage mandates, 2017 vs 2012, HFM Data (Page 9)
Exhibit 1.3: Sources of tension – selected regulations, 2017, HFM Insight (Page 10)
Exhibit 1.4: Average client RAUM of prime brokerage clients, 2013-2017, HFMWeek, Alphapipe (Page 11)
Exhibit 1.5: New launch prime brokerage business, 2016, HFM Data (Page 12)
Exhibit 1.6: Notable recent hedge fund launches, 2015-2016, HFM Insights (Page 13)
Section 2 – Revenue Hurdles
Citation: The evolving dynamics of the hedge fund industry – 2015 Global Hedge Fund Investor Survey, EY (Page 15)
Exhibit 2.1: Prime broker AuM by strategy, 2017, HFM Data (Page 15)
Exhibit 2.2: Prime brokers ranked by global revenue, 2013-2016, Coalition (Page 16)
Exhibit 2.3: Managers who know how much revenue their prime brokers expect them to generate, 2017, HFM Insights (Page 17)
Exhibit 2.4: Manager confidence in meeting their prime brokerage revenue hurdles, 2017, HFM Insights (Page 18)
Exhibit 2.5: The most important prime broker attributes according to hedge fund managers, 2017, HFM Insights (Page 19)
Exhibit 2.6: Managers willing to pay for value add prime brokerage services, 2017, HFM Insights (Page 20)
Section 3 – Selection and Oversight
Exhibit 3.1: Changes to prime brokerage relationships in the past 18 months, 2017, HFM Insights (Page 22)
Exhibit 3.2: Perceived tier of notable prime brokers according to hedge fund managers, 2017, HFM Insights (Page 23)
Exhibit 3.3: Annual net new prime brokerage mandates at top three US providers, 2012-2016, HFM Data (Page 24)
Exhibit 3.4: Annual net new prime brokerage mandates at top three European providers, 2012-2016, HFM Data (Page 25)
Exhibit 3.5: Bank CDS spreads of top 6 prime brokerage providers, 2011-2017, Markit (Page 26)
Exhibit 3.6: Prime brokerage provider stability matrix, 2017, Various sources (Page 27)
About HFM Insights
HFM Insights is the new research and analysis service by Pageant Media,
sitting within the company’s hedge fund intelligence network, HFM. The
division produces research reports and analytical articles on a variety of
topics in the global hedge fund industry, including business operations,
investor relations, technology and regulation. Leveraging Pageant’s
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Head of Research
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Stuart M. Kinnaird
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