Preqin’s Hedge Fund Analyst online platform tracks 141 prime brokerage firms providing services to hedge funds. With banks providing 83% of the prime brokerage services to the hedge fund industry, we take a look at how recent regulation guidelines have affected the dominant prime brokers, and the opportunities for specialist prime brokers to win mandates over the next few years as a result.
The table below shows the top 10 prime brokers in the hedge fund industry by number of known hedge funds serviced. Goldman Sachs is currently leading this group, providing prime brokerage services to 2,240 hedge funds (which account for 19% of the market share). Morgan Stanley is currently ranked second place, servicing 1,693 hedge funds, while J.P. Morgan is in third with 1,462 hedge funds serviced. Non-US-headquartered banks are represented in the top 10 by Credit Suisse (1,214), Deutsche Bank (826), and UBS (789). Interactive Brokers is the only specialist prime broker to feature in the top 10.
Following the 2008 financial crisis, banks have been subject to multiple reactionary policy regimes, among them Basel III. 2015 has seen multiple deadlines for Basel III, forcing banks to review the holdings in their balance sheet. Unprofitable clients will be under threat from banks’ prime brokerage units as they aim to meet the required capital, liquidity and leverage ratios; primarily at risk are the smaller hedge fund managers they service. Goldman Sachs announced that they would be cutting clients and increasing fees for others that are no longer profitable in order to comply with the new regulations. Rival US-based institution, Bank of America Merrill Lynch, also reported cutting hedge funds from their prime brokerage business over 2014 to meet the new regulatory requirements. Hedge fund managers that operate strategies involving high volumes of leverage could be under threat as banks strive to maintain their leverage ratios. In Switzerland, fund managers had to comply with CISA by the end of February 2015, needing to appoint a Swiss bank as paying agent for their funds. Ahead of the deadline, the Swiss National Bank instructed Credit Suisse and UBS to further boost their leverage ratios following concerns over covering the banks’ operational and legal costs. As a result, Credit Suisse has announced scaling back of their prime brokerage unit and plans for deleveraging.
As some hedge fund managers have been forced to look elsewhere for their prime brokerage needs, a new opportunity has presented itself to specialist prime brokers. Interactive Brokers, BTIG Prime Brokerage and Pershing Prime Services have all had a strong 12-month period growing their client base. However, in a recent survey conducted for the 2015 Preqin Global Hedge Fund Report, the largest proportion (25%) of fund managers that changed at least one service provider over the course of 2014 reported that their primary concern regarding changing their prime broker was outgrowing them. If the specialist prime brokers can manage the demand from the growing hedge fund managers, on top of their growing client base, 2015 could be another strong year for the specialist prime brokers. With Basel III continuing its roll-out to full integration in 2019, we can expect more scaling back from the largest investment banks, opening up more opportunities for specialist prime brokers.