Perhaps the second time is, indeed, the charm.
For the prime brokerage business, that is. It’s a business that has long been dominated by the largest bulge-bracket broker-dealers and banks – and their enormous balance sheets – catering to the hedge fund crowd who need these firms’ myriad services to make money. Bulge firms such as J.P. Morgan, Goldman Sachs and Morgan Stanley were more than happy to be a “one-stop shop” for these clients and earn revenue across several different business groups – trading, research, clearing, investment banking, etc.
But being a prime broker is not easy. It is a relatively low-margin, capital-intensive business. And that means a prime broker must have lots of cash at its immediate disposal to cater to its hedge fund clientele, as well as the broker’s other clients. During the boom years in the early 2000s, banks were flush with cash thanks to wider spreads, increased trading revenues and minimal technology spend, thus allowing them to cater to hedge funds of all shapes and sizes.
Then the financial crisis of 2007 came – revenues and balance sheets disappeared overnight, and only Wall Street’s biggest banks were able to survive. Many scaled back or completed shuttered their prime brokerage services. According to Aite Group analyst Spencer Mindlin, smaller firms known as “mini-primes” entered the space and saw business come their way.
“Following the financial crisis, you saw these mini-prime firms come in as hedge funds and trading shops realized they had to diversify their brokers – after the Lehman Brothers collapse and Bear Stearns sale,” Mindlin said. “Hedge funds looked for new opportunities to lessen their risk and diversify their business partners.”
Prime vs Mini Prime
So what is the difference between a prime and mini-prime broker? And how do they fit into this resurgence of prime brokerage business among smaller firms?
According to Scott Daspin, director of prime brokerage sales at Triad Securities Corp., a New York-based firm that is bulking up its existing mini-prime business, a mini-prime is typically an introducing broker to a large custodian, whereas a prime is typically a large custodian. Daspin told Traders that with a mini-prime, such as Triad, a hedge fund gets all of the benefits of having its custody with a larger custodian yet it receives the additional service of having an intermediary.
“Smaller firms need more hand-holding, and many need a way to outsource their back office and trading,” Daspin said. “It is often difficult to navigate the labyrinth of a large custodian. This is where a mini-prime can significantly reduce the workload by being an intermediary.”
Basel III
Daspin and Aite’s Mindlin told Traders that part of the resurgence of interest in the prime brokerage space and mini-primes is due to recent regulatory changes in the industry, such as Basel III.
Basel III regulations mark a titanic shift in prime brokerage business. These new regulations specify that banks hold a minimal amount of capital that is easily accessible to keep them from failure; they must also maintain a certain level of reserve capital and specified liquidity ratios. These regulations and requirements are all designed to stop a financial lending crisis such as the one in 2007.
“Hedge funds were driving demand for prime brokerage before the financial crisis,” Mindlin said. “But banks are throttling down and reassessing or shutting down clients that don’t make financial sense to their business models in this Basel III world.”
Mindlin added that several firms, including Goldman Sachs and Credit Suisse, have scaled back and told their hedge clients to take their business somewhere else.
“J.P. Morgan even sent out a white paper to explain this to clients,” Mindlin said. “And this has been going on for the last 18 months.”
Enter Mini-primes and Triad.
Triad Securities has been a full-service agency broker-dealer for nearly 35 years, and has specialized in providing the buyside with high-touch equity trade execution across the globe. The firm offers a full independent research offering and a full suite of prime brokerage services.
In line with its desire to grab hedge funds that have been dropped by the larger bulge firms, Triad offers a Web-based deal consensus platform – a system that provides real-time estimates on IPOs and secondary offerings.
The consensus platform includes U.S. IPOs and secondary issues, seven years of data, 6,000-plus unique symbols, 10,000-plus deals and access to 200-plus lead underwriters, and covers more than 30 sectors. It also provides multiple reports that include deals priced daily, updates or modifications, shelf updates or modifications, secondary issues that are filed, and listings that are expected every evening and for the remainder of the week.
Couple this system with Triad’s high-touch trading business, which fits hedge funds’ desire for a more relationship-based broker, and Daspin said his firm is ready for this business. The firm has an experienced operations and technology staff in place capable of supporting significant additional business, he said.
“Until now, we have relied on what has been steady organic growth,” Daspin pointed out. “We have a very experienced operations team, the majority of our technology was built in-house and we have recently hired a sales team. Additionally, our efficiencies with technology have provided us with the ability to take on significant additional clients.”
Growth Again
And that is just what hedge funds that need prime services want to hear. Recently, J.P. Morgan notified introducing brokers that had steered business to the bank that it was to stop doing such business in March 2015. The decision was part of the bank’s plan to become more selective about which hedge fund clients it serves with its balance sheet – something that is happening at a number of large investment banks.
The result has been that introducing brokers and hundreds of their small clients are having to transition to new clearing banks and mini-primes.
But Triad is not alone is this pursuit of hedge fund/mini-prime business. Other brokers such as Jefferies, Concept, BTIG, Weeden & Co., RBS, Santander, RBC, Citadel, Convergex and Wells Fargo are chasing a slice of the mini-prime pie.
Wells Fargo recently hired Eamon McCooey to head its prime brokerage services group and expand its prime brokerage business hiring. McCooey was formerly the head of U.S. prime brokerage at Deutsche Bank. A 20-year pro, McCooey spent his almost his entire career at Deutsche Bank. He spent his first five years at CIBC as an executive director.
And even stalwart players in the sector, such as Convergex, have seen an uptick in their business. According to a Convergex spokesman, the firm’s prime brokerage business has posted its best quarter ever.
“We’re seeing unprecedented growth as new clients come onboard and existing clients expand their relationships with us,” said Doug Nelson, Convergex executive managing director and head of global clearing and prime services. “Our flexible, multi-custodian model is striking a chord with funds that are being ignored or underserved in the big shuffle currently underway in the prime brokerage business.”
Convergex offers clients a multi-custodian model that gives them the choice of where to clear and custody their assets, and supports a seamless transition for clients who decide to change their custodial partner.
“New entrants can come in with better technology or offerings and scoop up these clients and business,” Mindlin said. “As the old story goes, now you have this prime/mini-prime resurgence where people are starting to take a look again at it.”
