BarCap Targets Top-3 Slot With Prime Brokerage Push

Acquisition of Lehman US business drives expansion

Originally published in the January 2010 issue

Many banks with strong commercial and retail franchises have shied away from offering prime brokerage despite its long record of expansion and traditionally high profit margins. Now several of the so-called universal banks have stepped up efforts, often combining acquisitions and substantial additional investment in infrastructure and personnel, to build prime brokerage franchises in the wake of the sector’s biggest ever shake-up.

Among the most aggressive new entrants into the business is Barclays Capital (BarCap). It acquired the Lehman Brothers US equity business out of administration weeks after the investment bank’s failure in 2008. Since then, BarCap has extended the equities business to Europe and is using it as a battering ram to launch prime brokerage services spanning fixed income, commodities and futures. At the same time, BarCap has gone on a hiring spree adding 750 staff.

Ashley Wilson, the head of EMEA prime services, joined BarCap in September. Wilson came from Merrill Lynch where he had headed equity prime brokerage and the yield enhancement trading desk for three years following an 11 year career at Morgan Stanley. Being from Middlesborough gives Wilson an unconventional background for an investment banker, but he is keenly aware of the opportunity that the unprecedented shake-up in the prime brokerage sector offers a blue-chip commercial bank like Barclays. Not only have competitors perished, but survivors, notably Goldman Sachs and Morgan Stanley, have faced unprecedented strain.

“The attraction of coming to Barclays is to have equities, fixed income and futures all in the prime brokerage,” Wilson says in an interview at the investment bank’s Canary Wharf headquarters. “Clients want it all in one business unit. The multi-strategy funds want the allocation of the balance sheet to encompass all of those areas.”

Wilson says he was attracted to BarCap by the clear vision of Bob Diamond and the management team about how to build the business. “It is a very aggressive plan of becoming one of the top three providers in prime brokerage given where we are starting from,” he says. “With the aggressive build out of the equity platform it is a very exciting time for Barclays and it is ramping up very quickly.”

Buying Lehman’s US equities franchise was a big statement of intent. That strength in US equities was transferred to Europe which went live on the system in early November. BarCap didn’t just acquire a business, but also got an equities trading technology platform that’s seen hefty investment in sub-millisecond technology. This lowers the latency of direct market access – a key competitive differentiator for quant fund clients. The technology has been rolled out across Europe, earning positive feedback from trading clients.

The hiring of 750 staff is split between two-thirds back office, mainly in information technology and compliance, with the remaining hires being front office. Now BarCap has a cash trading operation and is ramping up equity research, something that will continue in 2010. Expanding the service platform is seeing the bank become a general clearing member across several exchanges (thus being able to clear for exchange members) and it is also signing up to SWAP-backed ETF platforms. “With the equity rollout it means we can service not only the equity long-short strategies but all of the multi-strategy firms,” Wilson says. “The strategy is really to grow out all areas and have a full prime brokerage offering.”

Compared with a year ago the financial backdrop for prime brokerage is much healthier. Last autumn the refinancing markets froze up and convertible bonds couldn’t be refinanced. Now convertible bonds are being refinanced right down to single ‘B’ and even some unrated convertibles are being financed. It means prime brokerage is becoming less balance sheet heavy and that the credit contraction is easing.

Just as prime brokerage has changed, so have many of its practices. The freezing of UK investor assets following the Lehman collapse means that funds with a large US investor base want to transact with a US broker dealer so the investors get protected by the Securities Investor Protection Corp. With the Lehman buyout, Barclays does this for US stocks and has also moved to handle non-US securities from its European and Asian business in the US broker dealer entity. In Europe, some broker dealers are using what’s called bankruptcy by remote entity (which holds the unencumbered assets and is detached in a bankruptcy) but the set-up remains completely untested in practice.

Amid heightened concern about asset security hedge funds are demanding to face the strongest possible counterparty. Funds, essentially, want to trade with Barclays Bank plc because it is an ‘AA’ rated entity rather than a less highly rated offshoot of it. The appetite on the part of funds to deal with the highest rated counterparties is benefitting BarCap and other universal bank players like Deutsche Bank and Credit Suisse, while others like Royal Bank of Canada are building prime services offerings to sit along side administration and custody businesses.

“I think it has become a base line standard,” says Wilson, commenting on counterparty security preparation. “You have to have this suite of options if you are going to offer prime brokerage. Once you’ve got this base line standard then the old attractors which are cap intro, financing rates and margin terms become important again. But if you can’t offer a multi-currency US broker dealer, a highly rated entity to face the counterparties and if you don’t have some structure in the re-hypothecation then I think prime services is a very tough business to be in.”

Until the recent push into prime brokerage BarCap didn’t offer a capital introduction service. Now the bank offers that and strategic consulting through an asset management solutions group. In addition to helping managers attract capital the unit advises on investor relations and fund origination.

Wilson says size and performance are the defining characteristics of hedge funds that have prospered during the past tumultuous year. “I think the smaller funds over the past 18 months have really suffered,” he says. “As a percentage of outflows, they’ve suffered more than the larger funds.”

In the future, Wilson says that the key to being a hedge fund winner will be transparency and risk control, themes that fit naturally with the current vogue to launch funds with UCITS wrappers.

Until a year ago, the leading prime brokers studiously downplayed the UCITS evolution. UCITS isn’t suitable for every strategy and won’t work for portfolios using substantial leverage or targeting illiquid assets. What’s more, UCITS strategies demand separate custody arrangements so eliminating one strand of the prime broker’s lucrative hedge fund fee mix.

As a new entrant in prime brokerage, BarCap is adaptive to changes in the market. “A lot of firms are setting up UCITS wrappers for their funds because of the daily liquidity and transparency,” Wilson says. “I think that there are a lot of services such as the synthetics that UCITS funds require – even if custody goes elsewhere – that a prime broker is going to provide. Whether it’s good news or bad news for prime brokers, UCITS funds are coming so we need to be ready for them. It means infrastructure in the prime broker has to be much more advanced than previously.”

Wilson is straightforward about the bank’s ambition in prime services. “To put Barclays into the top three is the ultimate goal,” he says. “I think we have the product offering to get there and the balance sheet and credit rating. With the growth of the equity platform there is no reason why we shouldn’t succeed. That’s what I’d like to attach my name to: being part of this growth.”