Tuesday, September 15, 2009

The Prime Brokerage Business: One Year Out, Where Are We?

Dushyant Shahrawat, senior research director, securities and investments, TowerGroup, examines the fall out for the prime brokerage business one year after the collapse of Lehman Brothers.
It has been one year since the collapse of Lehman Brothers, the fall of Bear Stearns and the hectic sale of Merrill Lynch to Bank of America.  One can argue that the biggest impact of this string of events within the financial industry has been on the prime brokerage business. What has changed? The prime brokerage business has been impacted and has changed in the following ways:
1) The demise of two major prime brokers (in Lehman Brothers and Bear Stearns) has shaken hedge funds’ confidence in their prime brokerage providers
2) The events of just a few months have dramatically changed the relationship between hedge funds and their prime brokers for a long time to come. Cosy relationships have been questioned, and both hedge firms and prime brokers are re-evaluating their mutual association.
3) The competitive dynamic of this business has changed, with Goldman Sachs and Morgan Stanley dropping in market share from an estimated 52% of the global prime brokerage business in 2007 to under 35% in 2009. New players such as Fidelity Investments are entering, and several other firms are waiting on the sidelines.
4) Large Wall Street brokers have been deprived of a major and steady stream of revenue from the prime brokerage business. The estimated $12.5 billion that US brokerage firms make from the prime brokerage business may well see a 20% cut in the next few years.
5) Client perceptions and attitudes about their prime brokers have changed drastically during the crisis. Hedge funds have become more sensitive to the stability of their prime brokers and are demanding their prime brokers segregate client assets so that they are not overly exposed to the prime broker. 
6) Finally, a major trend that has emerged is the shift to a "multiprime broker" model. That is, hedge funds that used to rely overwhelmingly on one or two prime brokers are now hiring multiple prime brokers to spread the risk of doing too much with particular firms. Is the trend towards multiprime brokers a flash in the pan, or is it here to stay? We think this is a longer-term trend and will not reverse itself anytime in the future.

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