Prime Brokerage?

I have noticed an interesting article published yesterday in the daily economic French newspaper Les Echos on the perspective for Prime Brokerage houses in 2009.

Changes in leadership:
The Prime Brokers used to rule the world of Hedge funds. Considered as "the best friend of the hedge fund managers", the investment houses proposed traditionally their services in execution, clearing, lending securities and financing leverage.

The classification of the top 3 in 2007: Goldman Sachs, Morgan Stanley and Bear Stears cumulating 70% of the market shares has changed in 2008. The risk of having one single Prime Broker was clearly identified in 2007 and in September 2008 with the failure of Lehman Brothers, as one of the major operational risks for hedge fund managers and since then, they have re-distributed their brokerage agreements into several houses. The difficulties of UBS as a bank also has triggered some fears of insolvency.

Consequently, the market has been reshuffled with business flowing into medium size players. Credit Suisse in London has managed the crisis better then its peers with less exposure in credit strategies; Newedge has capitalized on its leadership position as a clearer in Futures to enlarge its offering to more hedge fund strategies and HSBC has announced recently, its intention to expand its Prime Brokerage activity.

Changes in activity?
More than 30% fall in hedge funds' assets, the ban of short selling by most regulators during 2008 and the higher costs of financing are all together reasons to believe that the business model of the Prime Brokers is shrinking.

To counter that trend, most of the Prime Brokers are entering the traditional market to expand their historic client base. Thus, the launch of UCITS3 vehicles by hedge funds and traditional managers is an opportunity for them to sell their know how in executing and clearing derivatives.

Outlook:
- development of a second tier Prime Brokerage market for smaller hedge fund managers (under 50 millions euros), rejected by the top 5 players
- increasing use of the CFD market to buy and sell securities as an alternative to short selling
- the use of leverage will diminish over the next 3 years with the overall move towards regulated funds (with limited leverage) and less offshore registrations (allowing unlimited leverage).