The prime brokerage industry is back to its best. After a few turbulent years stemming from market volatility, rising interest rates, geopolitical turmoil, inflation, soaring energy prices, client performance, fee pressures, a mini banking crisis, looming regulation, constant tweaking of risk models, rising client complexities and the notorious Archegos saga… well, things are looking up.Not that the seemingly never-ending list of aforementioned market occurrences had noticeably hindered the prime business. The ‘one thing after another’ era was a thorn in the side for a segment that is particularly sensitive to market forces impacting its clients’ appetites for lending and other prime services. But the headwinds have subsided, and the tailwinds have finally arrived in the form of new fund launches, a rise in allocations and increasing returns for funds, not to mention the continuing emergence of multi-strategy hedge funds. Prime brokerage is an industry which thrives off its clients’ growth, and that’s exactly what we’re seeing now.“Year-to-date, we’re seeing for the first time in many years a notable uptick in new fund launches and spin outs from bigger places,” says Jack Seibald, managing director, co-head of Marex prime services and outsourced trading. “Within that, there’s more billion-dollar and above launches in the last twelve months than there were in the preceding several years. That’s adding a level of interest in the sector again by allocators. From our cap intro team, we’re certainly seeing from the allocator community renewed interest in hedge funds.”According to Coalition Greenwich, the top dozen investment banks offering prime services saw revenues rise to a record $20.4 billion in 2023. Meanwhile, with regards to equities, revenue deriving from prime brokerage compared to trading shifted from a 30% versus 70% ratio a decade ago, to 40% to 60% in 2023.Dominic Rieb-Smith, managing director, international head, prime services sales, JP Morgan, refers to the past year as “a standout”. Meanwhile, Patrick Travers, head of distribution at Clear Street, says he agrees with the sentiment around it being a good 12 months for prime brokers: “From our perspective, the markets have remained strong with pockets of volatility which tend to allow for investment opportunities and increased balance activities which are key drivers across the equity finance landscape.”In addition to the billion dollar-plus launches, CIBC Mellon also points out to us the noteworthy increase in scheduled fund launches with assets under management of $500 million or greater – up almost two-fold on what was observed in 2023.Penny Novick, global co-head of prime brokerage at Morgan Stanley, picks up on this point, stating: “With heightened dispersion across equity markets, hedge funds continue to see strong opportunities to generate alpha globally, which has led to increased levels of gross exposure being deployed across the fundamental long/short universe. “Additionally, multi-manager hedge funds have continued to win the lion’s share of the new capital coming into the industry as they have been rewarded for their ability to mitigate risk while still delivering positive alpha to their investors. The positive performance combined with markets trading at all-time highs and elevated gross leverage across the hedge fund client base has meant prime brokerage balances have reached peak levels.“Views from the allocator universe towards the broader hedge fund industry also remain positive, and while this hasn’t necessarily led to net inflows to the industry as a whole up to this point, the forward-looking expectations based on our recent Investor Survey would point to increased allocations to hedge funds in the next 6-12 months, which we expect will also have a positive impact on the prime brokerage business.”We spoke to around a dozen primes across this feature, and anecdotally, there were also countless examples of growth, including – but not limited to – an uptick in growth in Europe, something backed up by a recent IFR article titled ‘Europe’s hedge fund industry is taking off after lost decade’, while there was also positive news out of APAC and opportunities highlighted in the Middle East and Australia.And the purple patch isn’t confined solely to the largest players, the chasing pack, or the plucky young upstarts – the overall PB pie is growing, meaning everyone’s slice is now more lucrative than ever before. Bigger and betterJust five years ago when JP Morgan surpassed $500 billion in prime brokerage balances, the bank’s head of global head of prime finance, Jonathan Cossey, quipped: “Next stop, one trillion!”. Well, fast forward to 2024 and the PB behemoth and its counterparts in the ‘big three’ are all reportedly around that coveted milestone.Data from Convergence tracking the top 25 prime brokers showed their market share grew from 83.3% in April 2023, to 92% in 2024. Goldman Sachs, Morgan Stanley and JP Morgan all increased their market share substantially, despite the former two seeing drops in the number of funds they have relationships with. According to Convergence data, JP Morgan saw both new client additions and a double-digit market share percentage growth.“I think the last 12 months for us in particular have been standout,” says Rieb-Smith, which has logged its best score in our sister title Global Custodian’s Prime Brokerage Survey since at least 2016. “In terms of client demand and what we have to offer, I think we’re really unique and we have benefited from that.”Part of this has been down to the continuing rise of multi-strategy (multi-strat) funds which have very sophisticated and specific demands which can only be met by certain service providers with scale and a broad offering covering a range of asset classes.On the topic, Rieb-Smith adds: “We’re in an environment where you’ve seen the macro community morph into multi-strats (because they’ve gone into equity strategies whether that be volume, capital markets and ultimately quant). Then you’ve got the quants who have started to look at fixed income products. These could be systematic, macro, or systematic credit funds, but you’ve seen more and more of those firms evolve into what look like multi-strat strategies. There are also the multi manager platforms that, in order to be fully diversified and attract the capital that they’re after, have become multi asset and therefore could be bucketed as multi-strat.“If you look at what those firms need in terms of prime-related services, well, cash PB and synthetics are just the basics. Those are the relatively commoditised parts of the business. There aren’t many banks that are organised the same way as JP Morgan, whereby my team in prime financial services sales are responsible for marketing not only all those prime finance related products, but all our clearing products as well.”“When you go through these really volatile periods of time, if the multi-managers that are really well diversified do come out stronger than monoline hedge funds, then there is an argument for investors. That’s why the money’s with them and they will probably attract even more capital. They are now trading in all these other asset classes. They need a financing platform to support all of that. We’re one of the only providers that can do all of that for them. So you can see how this growth and momentum just starts to really build over time.”JP Morgan’s rival Morgan Stanley have been serial outperformers in the aforementioned Prime Brokerage Survey for some years now – picking up the Best Prime Broker accolade in 2022 and an Overall Excellence Honour in 2023 – and 2024 was no different, beating the global average by 44 basis points. The bank also highlights to us how “as a global multi-asset class prime broker, we are structured to deliver the widest range of services regardless of strategy type or product complexity”.“At Morgan Stanley prime brokerage, we continue to be focused on growing our market share with existing clients by leveraging our unique integrated investment bank and firm strategy to deliver holistically across advisory, financing and sales and trading as well as our ability to tap into wealth and asset management channels to provide solutions to our hedge fund clients,” explains Novick. “Additionally, we remain vigilant in working with emerging talent early and providing them differentiated resources across consulting capital introductions, talent management, technology and client service to help these new entrants launch their businesses successfully.”The big three can sometimes be passed over when it comes to media coverage of the prime brokerage sector, simply because of how far out in front they are with regards to market share – believed to be somewhere between 40-60% depending on metrics and who you talk to – but their capabilities and service levels are not dropping and there are still billions of dollars being invested between them into the technology underpinning these units. The challengersBut the growth of the overall pie is also benefitting players outside of the top three, as the headline of this piece suggests.Ever since the exits of Credit Suisse and Nomura from the business – along with Deutsche Bank’s sale to BNP Paribas back in 2019 – the prime brokerage landscape has been dramatically shaken up to the benefit of those remaining in the business.Over the past year, each of the top 25 primes have increased their market share – according to Convergence – with 16 of those experiencing double-digit percentage growth.Some of the larger funds who were contemplating their next move following an exit of their previous provider moved up the table to the big three – which they likely already had relationships with already – while others switched to some of the ascending players in the industry.In addition to this – and somewhat because of these new funds – there has been a trend of the biggest prime brokers offboarding clients or limiting access for numerous funds, leading to many mid-tier PBs looking to move upstream and ambitiously add clients who have either fallen foul of exiting primes or been offboarded. “You had a flurry at the time, and then it slowed down, but we’re still seeing trickles of that business two years later,” explains Seibald, referring to the exits of other primes. On the topic of offboarded clients, he adds: “Emerging and mid-sized managers continue to be, for the most part, ignored/shunned by the bulge bracket prime brokers as the largest participants have been able to build their books with more desirable, larger revenue producing funds that found themselves in need of alternative banks following the demise/exit from the business of several of the largest players. “This has created an ongoing opportunity for mid-tier prime brokers, particularly those with broad asset class and geographical capabilities comparable to those of the bulge bracket banks. This is an ongoing pattern that we suspect will continue for some time.”Some of the aspiring players are present in the Prime Brokerage Survey, with outperforming scores set by players including Pershing, CIBC Mellon, Marex, Cantor and TD Securities. Clear Street is also continuing to make waves, despite being a much newer player on the scene.For Marex – previously TD Cowen – a new chapter has begun under a new owner, and the transaction has been relatively seamless with the prime broker retaining its team members, and even adding talent. Seibald added that under Marex, the prime brokerage unit is starting to explore opportunities in segments of the market it previously had little to no exposure to, but where Marex is a prominent participant, specifically, commodities and futures.Seibald’s team is joining in the upstream movers by some of the players named above, along with the likes of BTIG, Interactive Brokers, JonesTrading, and near to a dozen of the largest banks. It should be noted that in a market which has experienced provider exits, the shedding of less profitable clients and with looming increased capital requirements – don’t underestimate the lure of staying power and commitment to the business.Multi-strat growthAlong with the opportunities from wanting clients, it’s really been the rise of multi-strategy hedge funds which continues to benefit the industry, particularly players with diversified capabilities across all of the asset classes and securities, as well as in the futures and commodity space. This trend, and shift away from an equity-centric sector, has cemented these prime brokerage divisions as the jewel in the investment banking crown for many of the largest players in financial services.“A lot of the really big funds have taken in a lot of the assets that are coming into the marketplace,” says Aaron Steinberg, head of prime services at BNY Pershing, “A lot of that money from the institutional allocators, has been funnelled to a number of very large multi strategy and or multi manager platforms that those investors are just more comfortable with. There’s been a consolidation of where the assets are in the marketplace, and the biggest of the funds have gotten bigger. “We started to see a little bit of what I imagined was going to be the evolution of that market, which is a number of strong portfolio managers from those multi manager platforms coming out, launching their own funds. And we’ve seen some significant launches this year in that space. We’ll probably continue to see that trend.”With two fewer major players in the space, the competition has been heating up and requires significant investment. Some of the banks behind the big three have been aggressively looking to capitalise on the continuing trend, with lots of positive noise around Bank of America, Citi, BNP Paribas and Barclays. It’s no easy thing to service these funds though, with significant investments, talent and scale required.Outside of competing on capabilities, tech and the ability to service a range of strategies, one thing that shouldn’t be underestimated is the importance of client service. It’s for this reason that the category is such an important mainstay of the Prime Brokerage Survey and while not the ‘sexiest’ attribute of a prime broker to talk about in this fast-moving world, it is critical none-the-less.“If you read some of the more recent Global Custodian surveys over the past few years, specifically as it relates to our business, one of the things that is stood out is the high level of client service,” adds Steinberg. “As all firms are looking to create more automation and create a stronger technological base and frankly, reduce overhead costs, something that’s gotten lost in that is that prime brokerage has traditionally been a high level of touch client service model. “That’s what drives clients’ ability to get the services they need, not only from the prime broker, but from the broader bank itself. A lot of the clients that we’re talking to – again, the big multi-platform, multi strategy funds – they want to have enough counterparties where they can invest how they want to when changes happen in regulation – whether it’s around RWA or whether balance sheet changes for a specific bank or there’s buying opportunities, but they also want to be really valuable to those counterparties as a whole and in total. And so, they want to be more to their counterparties, and we want to be more for our clients.”Travers concurs: “With regards to the sell-side and prime brokerage specifically, we are all in client service on a daily basis,” he says. “The premise of what we do day in day out is to facilitate our clients’ needs and enhance their business every day. Regarding the client service team, we find that the best way to differentiate our technology offering is to have best in class client service personnel.”Challenges ahead?It’s not all sunshine and rainbows in the prime brokerage world, however. Looming regulatory issues and the ever-increasing complexities of the business have led to constantly evolving risk management systems.Among the major changes is the Basel III ‘endgame’ update, the widely anticipated capital requirements hike for Global Systemically Important Banks (G-SIBs). Last year, US regulators unveiled the new capital rules for lenders, with G-SIBs seeing an increase by an aggregate of 16%.The requirements align the US with Basel III standards which were agreed following the 2008 crisis with capital, leverage and liquidity requirements rolled out in the ensuing years, as the latest reforms look to end the reliance on internal models in the US for estimating risk and introduce standardised frameworks. While there is no exact timeline on the final ruleset being published and implemented, banks are preparing now and certain prime brokers have become increasingly sensitive to strategies with more punitive RWA and capital treatment. Additionally, in February, the Federal Reserve Board released four new hypothetical elements as a means to analyse different risks within the banking system. Two of these scenarios include two sets of market shocks which observe the hypothetical failure of each bank’s five largest hedge fund exposures under unique market conditions. This analysis will bring to light the results of a hypothetical major market disruption and the implications of it. Most recently, Bloomberg reported that the Bank of England is also reviewing lenders’ practices within their prime brokerage business as part of a long-running review into their exposure to hedge funds and other non-banks.The arrival on the radars of various regulators stems from the fallout of the collapse of Archegos Capital in 2021, where its various prime brokers – of which there were many – were not fully aware of the size of the fund’s positions with other banks, and as the Bank of International Settlements put it, they thereby underestimated its overall leverage and impact on the markets in which it was active.The silver lining was a complete reassessment of client relationships within the prime businesses of the biggest players and a wake-up call which was spun as ‘good’. However, the downside has been increased regulatory scrutiny.“We’ve seen many of our competitors adjust and ‘revisit’ both their counterparty credit and risk policies following past events in the marketplace,” says Travers, though Clear Street had no involvement in the Archegos saga. “We believe that a robust risk and credit policy coupled with a stringent KYC policy will be key to avoiding another market event specifically within the prime brokerage space.”ABN Amro adds: “The post-Archegos stabilisation trend is also evident with central clearing of OTC products, increased capital requirements and introduction of UMR. This has led the business scope for prime brokers to expand to full collateral management optimisation across multiple industry areas, with the largest benefit to UMR impacted clients. In addition, there is also interest in more efficient financing solutions, such as repo paired with custody.”Of course, there are multiple other market structure developments and regulations for prime brokers to contend with from markets moving to reduced settlement cycles to new cyber security requirements. Ultimately, in 2024, the headwinds should only be a footnote to the main story – and that is around an industry reaping the rewards of a patient approach through some frankly wild years post-Covid. There was a phrase used throughout our outreach that the biggest are getting bigger – with regards to hedge funds – but that growth also relates to the entirety of the prime brokerage business. What this means is a likely increased investment and focus on these units from the largest players as this lucrative business begins to grow as an increasingly prominent part of each organisation. But they aren’t the only benefactors – it’s been a big year for primes of all shapes and sizes, and all those left in the market have lofty ambitions for the future.The post The prime brokerage pie is growing, which means bigger slices for everyone appeared first on The TRADE.