Analysis: Banks go toe to toe as Wall Street woos hedge funds

By Emily Chasan and Ross Kerber

NEW YORK/BOSTON (BestGrowthStock) – The battle to be the top dog in the lucrative business of clearing trades and lending money to hedge funds is heating up as a handful of U.S. and European banks are intensifying their push into the space.

Citigroup (C.N: ), Bank of America Corp (BAC.N: ) and other commercial banks are trying to win market share in prime brokerage, which provides services to some of the world’s biggest and best trading shops. But it will not be easy.

Goldman Sachs Group (GS.N: ) and Morgan Stanley (MS.N: ) (Read more about the money market today. ) have dominated the business for years, and JPMorgan Chase (JPM.N: ) joined the top of the rankings after acquiring Bear Stearns’ operation during the financial crisis.

Prime brokerage is a big business, generating more than $9 billion of revenue for Wall Street in 2009, according to the Tabb Group research and consulting firm.

And for the winners, the spoils can be impressive. Prime brokerages can have a multiplier effect on a bank, acting as a gateway to introduce hedge funds to other, even more lucrative, services.

Hedge funds have also expanded the market themselves by using more than one prime broker in the wake of the financial crisis. Tabb finds that hedge funds now have an average of 2.6 prime brokers, compared with just one before the crisis, so there could be opportunities for competitors to win business.

But firms are battling for a piece of a smaller pie, given that prime brokerage revenues this year are still expected to rank below the pre-crisis level of around $11.5 billion.

“To get business from one of the top tier players, you’re going to have to make an offering that has a more specialized approach,” said Tabb Group senior analyst Matthew Simon.

The second-tier players are also trying to dethrone the leaders through new investments, consolidation or by picking off employees at rivals with long-standing relationships with hedge funds.

For instance, Citigroup reports adding more than 70 people to its operation this year in a bid to attract more hedge fund customers.

Bank of America is making its presence felt after picking up Merrill Lynch’s prime brokerage business when it acquired the Wall Street investment firm during the height of the financial crisis.

The Charlotte, North Carolina-based bank says it has added about 300 new hedge fund clients this year. Assets under management at its prime brokerage more than doubled from 2009 to 2010, the largest gain of any firm in an industry survey this year by AR Magazine.

“We’re picking up market share and balances so when leverage does return, we would expect to see a significant jump in terms of business,” said Syl Chackman, co-head of global markets financing and futures at Bank of America Merrill Lynch.


Bank of America’s push is something of a surprise, given that the company sold its prime brokerage business to BNP Paribas SA (BNPP.PA: ) for about $300 million in early 2008.

Ironically, in the push to break out of the pack, BNP Paribas is becoming one of Bank of America’s chief competitors. BNP’s business, which had about 500 mostly U.S.-based clients at the time of the acquisition, was also among those that increased assets this year, the AR survey found.

The French bank is planning to roll out a big new global trading platform for its prime brokerage clients at the end of the first quarter of 2011, according to Samuel Hocking, head of prime brokerage sales.

Overall prime brokerage revenue for the industry is slumping due in part to the financial crisis wiping many hedge funds off the map.

More importantly, many Wall Street firms — and hedge funds themselves — have decided to reduce the amount of money that funds borrow to juice up their trading results.

That new conservatism reduces risk for the banks and the funds — as well as potential returns for both players.


Companies like Bank of America, Citi and BNP have watched the recent rise of European investment banks Credit Suisse (CSGN.VX: ) and Deutsche Bank (DBKGn.DE: ) like a play book.

Philip Vasan, global head of prime services at Credit Suisse, remembers “jaws dropping” in 2006 and 2007 when he told potential hedge fund clients that they should use more than one prime brokerage to diversify their risks.

But when Lehman Brothers (LEHMQ.PK: ) collapsed in September 2008, some funds got burned badly and went running to European banks to spread out their risk. Swiss-based Credit Suisse says it increased its hedge fund clients in its prime brokerage from 407 at the end of 2007 to 485 today while nearly doubling its market share among the top 100 hedge funds.

But some firms have still found it too difficult to gain traction in the competitive landscape. For example, First New York Securities, a global trading firm, launched a prime brokerage business with much fanfare in the beginning of this year. But it went on to sell it just eight months later to brokerage firm Direct Access Partners.

With the revenue crimped and the big firms competing harder than ever, more of the smaller investment firms could look to exit the prime brokerage business in the next few years, industry experts said.

As with most things on Wall Street, being a bigger player is better.

“The bigger portfolio you have, the more likely it is you can match up buyers and sellers and borrowers and lenders,” said Barry Bausano, co-head of equity prime brokerage at Deutsche Bank. “You generate efficiency through economies of scale.”

(Reporting by Emily Chasan and Ross Kerber)

Analysis: Banks go toe to toe as Wall Street woos hedge funds