Strategies for differentiation in prime brokerage and agency securities lending (Finadium subscribers only)

We’ve been seeing some patterns in our interviews of asset managers, institutional investors and hedge funds. The article below presents some strategic thinking for prime brokers and securities lending agents.

Finadium has conducted three major surveys over the last eight months – the first on large institutional investors, the second on hedge funds and the third on the world’s largest asset managers. We are now hearing similar enough themes that we wanted to consolidate our information and present ideas for strategic differentiation to our sell-side and agent lender research subscribers. While some of these ideas are certainly not new, the frequency with which we are hearing them discussed merits further attention at this time.

1) Service providers are successfully differentiating themselves through consulting services. While hedge funds rated consulting services less importantly than operations and financing as a critical prime brokerage service, the funds that mentioned it were enthusiastic and able to speak not only about the specific services they received but also about individuals who provided them. Meanwhile, large mutual funds and insurance companies are also talking about consulting or business services they receive from their agent lenders. This is the human element to an otherwise financial and risk oriented business. Perhaps it is a sign of the uncertain times, but hedge funds and asset managers are talking about the human connection in their service provider relationships. According to clients, this otherwise fuzzy stuff is making the difference for hedge funds and asset managers selecting and sticking with service providers.

2) Who foots the bill is a tough question, but managing costs together is easier. The largest funds in our interview groups – institutional investors, asset managers and hedge funds – expect service providers to pay for any cost increases due to financial regulations. In securities lending, this means that an agent would absorb the cost of indemnification before passing it on to their beneficial owner clients. For prime brokers, this means no increases in financing costs or wider spreads in OTC transactions. This is almost a matter of pride for clients, as our large survey respondents see themselves as the biggest and most important client bases for service providers. However, a different story emerges when clients start to talk about conversations they had with their service providers about how to mutually manage costs so that all parties benefit. For hedge funds, this could mean structuring a portfolio to rely less on a prime broker’s balance sheet and more on centrally cleared transactions or portfolio margining. For beneficial owners in securities lending, the corollary is a discussion about exactly how Basel III affects securities lending costs and what program changes could be made to keep those costs low. While fees may ultimately increase for clients under both scenarios, the conversation leads to a sense of cooperation that encourages a strong relationship and eases the way towards a conclusion.

3) Collateral management has been frustrating, but that doesn’t make it a less important topic of conversation. With some notable exceptions, clients are experiencing collateral fatigue. They have been hearing about collateral shortages for years now and securities lenders have been hearing about the need to accept more non-cash collateral. For clients engaged in OTC derivatives and beneficial owners able to accept diverse types of non-cash collateral, the next three months to two years will prove to be crunch time. The challenge for service providers is in thinking through how to re-present collateral management, this time making it more directly applicable to the client circumstance. The general discussion time is coming to a close; now the task is about meeting individual client understanding their own collateral challenges and opportunities.

While there are few if any universal truths in financial markets today, our survey work continues to reveal some useful ideas for strategy, marketing and product development going forward. Our 2013 survey of large asset managers on securities lending and collateral management will be out next week.

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