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As active strategies continued to outperform and hedge funds saw record assets under management, 2021 should have invigorated prime brokerage. Instead, it turned out to be a turbulent year for the sector.
Andrew Rae-Moore, Co-Head of Prime Brokerage Europe, Cowen, said: “2021 was undoubtedly a rough year for some prime brokers,” adding that 2021 will stand as a year that cleared out the prime brokers (PBs) on the periphery who didn’t have proper backing from management boards, underinvested in staff and technology, and who appeared to take a more cavalier approach to risk.
“We are left with a smaller but more able number of prime brokers, although we believe there may still be some further consolidation or exits to come over the next few years,” he told Traders Magazine.
One of the 2021 highlights was the collapse of a US-based hedge fund Archegos Capital Management. In addition to that, the meme stock short-selling squeeze, new curbs on Chinese education stocks, and fallout from the China property shake up resulted in a significant stress test for Prime Brokers, Rae-Moore said.
“A number of prime brokers exited the sector, largely driven by lack of robust and thoughtful risk policies and controls,” he said.
Meanwhile, prime brokers such as Cowen, “led by experienced PB hands’ and who have invested in people and the right technology over the years have enhanced their positions in a more consolidated landscape during 2021”, said Rae-Moore.
Josh Galper, Managing Principal, Finadium, confirmed that the success of 2021 for prime brokers depended largely on the firm.
“While Archegos losses caused some prime brokers to exit the market or scale back, others saw outsized demand as hedge funds sought prime brokers that were happy to accept their business and could offer value-added solutions, especially in technology,” he said.
Brad Bailey, Head of Market Intelligence at Clear Street, added that the Archegos situation was unfortunate, but shed a light on some of the underlying challenges in prime brokerage stemming from lack of investment in modern tools and a need for robust risk management.
“We also saw major primes like Credit Suisse exit prime altogether, pointing to a change in how large banks are thinking about prime as an avenue for business,” Bailey said.
He added that for years now, there has been a cycle of primes rethinking priorities, stopping services to certain types of funds, and “repairing rather than rebuilding their technology–or maintaining rather than improving”.
“The market has shown a clear need for a better prime experience–clients are demanding better tech and service,” he stressed.
Focus on Technology
Technology has improved dramatically in recent years to keep up with the faster pace of markets, global trading and new products, according to Rae-Moore.
“It is a significant cost to the business and the good PBs are the ones who continually invest in evolving their systems in order to maintain leading positions in the market,” he explained.
A general trend for this year seems to be an increased focus on automation and a push for real time data for clients, Rae-Moore said.
“Ensuring front to back flows are fully automated will allow PBs to publish close to real time information to their clients in terms of exposures, P&L, and margin,” he said.
Rae-Moore noted that clients want to be as up to date as possible and have the ability to react at speed when a market event or significant news hits the tape.
“Working in tandem with their prime brokers, who are often their main trading counterpart, is crucial in their ability to assess and react quickly,” he commented.
Galper said there are two ways to look at prime brokerage technology: client facing and internal: “We’ve seen different firms focus on both areas depending on their starting point.”
There are a finite number of large prime brokers and an increasing number of firms looking to make their marks on the sidelines, he said.
“The larger firms know that efficient balance sheet management is a key driver of competitiveness and have invested, and will continue to invest, in risk, operations and data management internally. Smaller firms cannot ignore balance sheet but we’ve seen some emphasize client reporting as part of their growth process,” he said.
According to Bailey, there is a trend toward spending on upkeep rather than new investment impacting risk, cost, access, speed, and data availability.
“By and large, technology spend at large bank-owned primes has gone up over time. However, it is not clear how much of that spend has been on attempts at modernizing their decades’ old technology nor how much of the spend actually made it way down to the benefit of hedge funds and other clients,” he said.
Bailey said: “We have to take the lessons of the past year and implement them in how we are serving clients today.”
There is no silver bullet–that is, there is no one piece of technology that is going to remake prime brokerage overnight and address every client’s problems, he added.
“Rather, as prime brokers we need to continue to develop and invest in better technology to help our clients keep pace with today’s markets, while also operating safely and in compliance with strong risk management,” he said.
He added that one of the best assessments of what needs to change in 2022 was said by research firm Coalition Greenwich in its 2022 top trends piece: “To capitalize, prime brokers will need to invest even more than they have in the past on technology and the processes for managing the provision of credit and use of the balance sheet. This will mean a bigger focus on truly real-time risk management technology to catch the next Archegos before it happens”.
