Hedge Funds More Willing to Switch PBs: Report

Hedge funds are increasingly willing to switch prime brokers in search of better financing and leverage terms, creating opportunities for new entrants and for established players with balance sheet capacity to target under-served corners of the market, according to a new report.

The report from Acuiti and TS Imagine, The future of prime brokerage: How buy-side demands are creating opportunities for new entrants, is based on a survey and series of interviews with senior executives at hedge funds and prime brokers.  It finds that prime brokers have become more selective in their offerings to hedge funds since the implementation of Basel III. According to the report, this has also come at a time of an acceleration in hedge fund launches, leaving some firms without sufficient access to leverage, especially among smaller funds and those running strategies outside equities.

More than half of respondents have had leverage reduced or margin requirements tightened on multiple occasions over the past five years, with 71% reporting a reduction in trading scope or volumes as a result and 53% citing lower returns for the fund as a result.

In addition, for prime brokers, the traditional stickiness of client relationships is weakening, with 57% of respondents saying they had switched or considered switching prime broker due to financing costs or leverage terms, and 55% saying they would find it easy to onboard with another provider.

“The findings suggest that there is significant opportunity for new entrants to enter the prime brokerage market to meet the demand from hedge funds,” the firms state. 

“Prime brokers’ ability to provide leverage has largely survived the post-crisis capital regime, but beyond the aggregate picture there are significant kinks in the system,” says Ross Lancaster, head of research at Acuiti. “Funds with lower AUM or more niche strategies are consistently under-served, and as with any market inefficiency, that creates an opening for new providers.

“The next phase of competition will be won on margin transparency, data quality and analytics rather than the traditional value-add services that funds are increasingly discounting,” he adds.

The report also finds that margin is becoming an increasingly important issue for hedge funds, and a source of frustration. Many hedge funds are now running sophisticated risk and margin management analysis and are calling for a more harmonised margin process across brokers. 

Data quality is another key constraint. The interconnectivity between clients, prime brokers, venues and clearing houses, combined with multiple ownership claims on individual securities, elevates the potential points of failure across the trade lifecycle. 

“Demand for prime brokerage services continues to expand as hedge funds grow in scale and increasingly adopt complex, multi-asset investment strategies,” observes EJ Liotta, head of prime finance and equity derivatives at TS Imagine. “At the same time, post-crisis capital requirements have made balance sheet capacity a critical consideration for prime brokers themselves, creating new challenges around financing, collateral and liquidity management.

“As a result, margin and capital efficiency are becoming increasingly important areas of focus across the industry,” he continues. “Technology now plays a central role in helping firms navigate this complexity, particularly through better data, greater transparency, and AI-powered analytics built on deep domain intelligence. The ability to understand exposures, optimise resources, and make informed decisions across the financing lifecycle is becoming an increasingly important source of competitive advantage for prime brokers.”