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April 27, 2016  

Banks Lose Market Share in Prime Brokerage

The latest data on hedge funds’ prime-broker relationships show most of the big Wall Street banks are losing market share while a number of smaller firms are gaining — confirming expectations that new banking regulations would shake up the field.

Perennial front-runner Goldman Sachs commanded 19.4% of the prime-brokerage market as of the first quarter, down from 21.7% four years earlier, according to Hedge Fund Alert’s Manager Database. No. 2-ranked Morgan Stanley experienced a modest year-over-year increase in market share, to 16.3%, but that’s down from 17.3% in 2012, when the SEC began requiring most hedge fund managers to register and disclose their service providers.

The newsletter’s ranking of the 25 biggest prime brokers, based on number of fund clients, also shows that the next four firms on the list have lost market share in the past four years. As of the first quarter, J.P. Morgan held a 13.7% share, compared to 15.1% in 2012; Credit Suisse held a 9.2% share, down from 11% four years earlier; Deutsche Bank held a 7.3% share, down from 8%; and UBS held a 6.7% share, down from 8.7% (see ranking on this page).

Indeed, of the top 10 prime brokers in the league table, only one — No. 7-ranked Bank of America — has shown an appreciable gain in market share in the past four years, from 4.4% to 5.9%. The next two firms in the ranking, Citigroup and Barclays, have remained roughly flat, while No. 10-ranked BNP Paribas has slipped to a 2.9% share, from 3.4% in 2012.

Further down the league table, however, a number of firms have shown impressive gains in market share. Wells Fargo, which entered the prime-brokerage arena via its 2012 acquisition of Merlin Securities, had a 2.3% share at the end of the first quarter, versus 0.1% four years ago. Interactive Brokers held a 1.6% share, up from 0.5% in 2012. BTIG, Societe Generale and HSBC also notched sizable increases in market share.

New banking regulations stemming from the Bank for International Settlements’ Basel 3 mandate have made it increasingly expensive for the major prime brokers to finance their clients’ trading activities. In response, banks including Credit Suisse, Goldman and J.P. Morgan have taken steps to cull smaller, less-profitable hedge fund clients — the results of which are reflected in their dwindling market shares.

“All of us have been decrying this regulation, but it is rebalancing the landscape of the prime brokers and how they fit the overall needs of the banks,” said Stephen Casner, chief executive of New York treasury-management shop HazelTree. “Maybe the regulations are doing their job.”

Industry professionals predict European banks in particular will continue to pull back from the prime-brokerage arena, with some exiting entirely. That’s partly because they aren’t as far along as U.S. banks in bringing their operations into compliance with Basel 3. Once they fully shore up their capital bases, the European banks may have little appetite for prime brokerage.

A separate ranking of custodians shows that several big banks have lost some market share in that sector as well (see ranking on Page 9). J.P. Morgan continues to lead the league table of custodians, with a 52.3% share of the market as of the first quarter. But that’s down from 58.3% a year earlier. The market share of No. 2-ranked BNY Mellon, meanwhile, slipped to 50.6%, from 54.6%, during the same period. Other banks with shrinking market shares, year over year, include BofA, Citi, Credit Suisse, Morgan Stanley and UBS.

Among the gainers are No. 3-ranked Goldman, whose share of the hedge fund custodian market increased to 41.5%, from 40.9%. Even bigger advances were made by No. 11-ranked Northern Trust (with a 23% share, up from 12.4% a year earlier) and No. 13-ranked Wells (18.2% share, up from 12.7%).

Both the prime-broker and custodian rankings are based on market share — determined by the number of client funds in the case of brokers, and by the amount of gross assets in client funds in the case of custodians. When a fund reports more than one prime broker or custodian, full credit is given to each.

The newsletter’s Manager Database tracks 3,074 fund operators managing a combined 10,515 vehicles with a total of $5.5 trillion of gross assets under management.

The rankings capture prime-brokerage and custodian relationships only among SEC-registered investment advisors and so-called exempt filers — typically firms with at least $25 million of assets — and thus understate the business of firms that cater mainly to smaller managers and those that don’t operate in the U.S.