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April 16, 2007

New Kid on the Block

Upstart doesn't expect all the stock lending business. It just wants to wet its beek

By Gregory Bresiger

There's a lot of fat in the securities lending services sold to hedge funds by the biggest prime brokers. At least that's what the leaders of upstart securities lender Quadriserv contend, as they target the sweet spot in the industry: hedge funds. These funds' voracious appetite for borrowing stock for short-selling strategies is well known-and a key component to prime brokerage profitability.

But Quadriserv execs say they have a broker-neutral securities lending platform that won't tie funds to prime brokerages.

"Now when [hedge funds] need to borrow a security and get a locate on it, they need to execute with that same prime broker," says Gregory DePetris, one of Quadriserv's founders. And that often means higher costs, he says.

The firm's new automated agency model is a kind of cooperative securities lending service designed to take advantage of unbundling. By decoupling a piece of the prime brokerage service, Quadriserv hopes to convince hedge funds that they can lower funds' borrowing costs.

Tighter Pricing

If a guy is long margin stock, he may be borrowing at Fed Funds plus 30 [basis points]. We'll show him how he can do it at a Fed-plus-15 rate," says Joseph Weinhoffer, founder and CEO of Quadriserv. "And now he knows he can borrow money from us cheaper than he can from his prime broker."

Quadriserv's supporters say the securities lending market today is opaque, reminiscent of Nasdaq in the early 1990s.

Josh Galper, managing principal of consultant Vodia Group, sometimes advises clients to use the firm. He says Quadriserv is an unbundling play.

So maybe this upstart can lend cheaper and shine light on the market. But does it have the flow? To do battle with the primes, Quadriserv must convince prospective clients that it does.

"When you're dealing with an illiquid over-the-counter marketplace, you don't inherently know that there's enough internal liquidity there, as you would with Goldman [Sachs] or Bear [Stearns]," says one trading industry player who knows Quadriserv, but asked not to be named.

Early Stages

According to Quadriserv, the firm has

commitments from custodians for $2 billion in exclusive assets. Quadriserv also has a $50 million letter of credit with the Bank of New York. The firm isn't profitable yet, since the brokerage arm only launched a year ago. But Weinhoffer expects profitability in the next 12 to 18 months.

Brad Hintze, an industry analyst with Bernstein Research, believes prime brokerages are ripe for competition. For example, say a fund is paying a legitimate high price covering a hard-to-find stock as a short, Hintze says. But the market shifts. Now the security is no longer expensive.

"Nevertheless, you're not going to get a cut. They [the prime brokers] are going to leave it at its original price," Hintze says.

DePetris believes Quadriserv's agency model will appeal to hedge funds that have the ability to borrow stock away from their primes, enabling them to save money. He hopes many will believe it isn't necessary to give all their business to the major prime shops like Goldman Sachs, Morgan Stanley and Bear Stearns, all of which declined to comment for this story.

"There's room enough in the world for both of us. We provide a pretty targeted service to a pretty targeted constituency," DePetris adds.