The phrase is well known: timing is everything. And Société Générale has deemed that now is the right time to enhance and accelerate its equity PB offering. The regulatory backcloth informs this strategic decision. The likes of the AIFMD and EMIR are fundamentally altering the relationships prime brokers and their clients currently enjoy, whether it be through new asset segregation rules, new capital requirements, or changes to the ways that hedge funds can fundraise. Simultaneously, banking regulation in the US and Europe is putting pressure on all banks to review the profitability of their businesses by bringing about a greater focus on achieving an appropriate return on capital and liquidity – both increasingly scarce resources – as well as to manage concentration risk, regulators being keen to prevent a ‘too big to fail’ PB scenario.
As such, SG’s move may raise eyebrows: why expand in a market where doing business is becoming more challenging? Duncan Crawford, Global Head of Alternative Investment Solutions at Newedge, says, “Current leaders in the equity PB space are re-balancing and re-scaling their activity, notably with regard to secured financing, which is considerably more capital and liquidity-intensive under the new Basel regime. In turn, this will lead to a re-pricing of this service, as well as a clearer focus on profitable client relationships.”
“It is this combination of re-pricing, re-balancing and re-scaling that creates opportunities for us to grow our prime brokerage offering, with a particular focus on equity prime, via Newedge now that we’re fully integrated into Société Générale Corporate & Investment Banking’s (SG CIB) Global Markets division,” says Crawford.
Whilst well known for its dominant CTA and quant franchise, it is perhaps one of the industry’s best-kept secrets that Newedge has been servicing a broad range of equity strategies for more than 14 years. Crawford continues, “Integrating with SG means that we have hit the accelerator in terms of enhancing our existing equity prime business. More than 40% of on-boarding so far this year has been equity hedge funds, ranging from traditional long/short, to equity market-neutral, statistical arbitrage, and niche sector specialists.”
The stars of 2014, event driven and merger arbitrage, are also part of the roster now. All in all, it sounds like a pretty broad cross-section of the equity hedge fund community.
Ownership consolidation makes a difference because SG brings capabilities that Newedge, as an independently operated unit, never had. Crawford elaborates: “SG houses broad and deep inventories of securities; it is the global leader in equity derivatives; it has a rock solid balance sheet, significant financing capabilities and capacity; it boasts a huge equity research franchise, and offers a range of algorithms to help funds optimize execution.”
Equally, acquiring Newedge means SG now gets the prime brokerage and agency FCM (Futures Commission Merchant) it needed to be able to provide a full front-to-back global markets offer commensurate with its peers.
Although Newedge has been doing stock lending and servicing equity funds for more than a decade, Crawford is quite open in admitting, “We were handicapped by a lack of inventory in the past.” Now funds working with Newedge benefit from the combination of a single cross-asset PB platform with the powerhouse that is SG Cross-Asset Secured Financing.
The solid foundations of security inventoryalso support extra financing options. On top of margin, repo and collateral financing, SG CIB now brings competitive synthetic financing capabilities, underlined by it being voted #3 ‘Overall in Synthetic Finance’ in the The Global Investor/ISF Synthetic Finance Survey 2014. “SG’s strength means that we now have the tools to support an expanding base of Equity HF clients,” says James Shekerdemian, Global Head of Prime Brokerage Sales.
Balance sheet efficiency
“When it comes to cross-margining we are one of – if not the – strongest on the street,” says Crawford. Whereas some more siloed brokers may charge margin independently, Newedge has always looked at cross-asset portfolio risk holistically. Being able to calculate margin on a portfolio basis maximizes potential for netting off margin requirements, even when instruments are held across multiple asset classes and trading venues. This helps hedge funds to be efficient in terms of margin requirements, which is particularly useful for leveraged arbitrage strategies. It also helps hedge funds to maximize their unencumbered cash, which may increasingly be needed to post as collateral against cleared derivatives that might once have had no initial margin requirement.
Newedge’s cross-margining goes far beyond exchanges’ own cross-margining: “We have a sophisticated, solid and broad in-house platform,” explains Shekerdemian. “Anything liquid can be cross-margined, sometimes even if the instrument itself has no daily market price; so long as its underlying is liquid, cross-margining is available at Newedge.” Marked to model equity or currency options can therefore qualify for cross-margining, as they can be priced by the Newedge risk team and have a liquid underlying with an Exchange Delivery Settlement Price (EDSP).
The origins of portfolio margining are to be found in Newedge’s roots as a futures broker. “Cross-margining started with futures markets, with equities and fixed income bolted on later, all under the same legal entity,” recalls Crawford. “In contrast, some competitors had legacy departments, with separate legal entities and separate P&L streams for each asset class. This made cross-margining physically impossible – or at least internally politically difficult due to territorial siloes.”
The Newedge Advisory Group is renowned for its thought leadership pieces in the quant, macro and CTA space, but the absence of in-house equity research also hampered Newedge’s efforts to win equity hedge funds. Now they can tap into SG’s research franchise. “We have well-established and highly ranked research teams that clients are keen to access,” says Shekerdemian. SG CIB organizes its research on a pan-European basis and is particularly sought-after in the natural resources space. Newedge was historically associated with systematic strategies, but now the equity research on offer is starting to attract more traditional fundamental equity long/short strategies.
Execution offers another edge for Newedge, as clients can now access SG’s equity execution platform. Shekerdemian continues, “SG has been, and continues to be, a strong quant house. This is part of their DNA and it has helped them develop their algo suite.”
Direct Market Access has been offered for years, and SG also provides high-touch, personalized service from teams of specialist sales traders. Newedge’s agency model is client-driven and tailors execution to suit customer needs, so some will opt for platforms on the desk, others write FIX messages directly to Newedge’s middleware, others send files to the Care Desk and some still prefer using the phone.
Newedge was always a leader in terms of market access, offering 85 exchange memberships at the latest count. Combined with SG, that number rises to more than 155 markets and execution venues.
The ownership consolidation has not altered the focus on liquid assets. Newedge received The Hedge Fund Journal’s award for “The Leading Prime Broker for Liquid Strategies”. As such, Newedge is very well geared towards servicing managed accounts, UCITS funds and ’40 Act funds, as well as traditional offshore hedge funds and AIFs. These structures all have their own quirks. For instance, UCITS funds do not, strictly speaking, have a prime broker, and UCITS V will usher in strict depositary liability. Newedge is experienced at working with the other service providers involved in these structures.
Elsewhere on the regulatory front, the roll-out of OTC clearing in the US and EU continues. Newedge’s experience at clearing OTC derivatives, in the energy markets, predates the regulatory obligation to do so by about a decade. More recently, it has broadened its offering to cover IRS and FX asset classes and is a member of every major CCP.
Additionally, Newedge can assist with reporting trades and collateral to repositories, and discussions are ongoing with custodians about the depositary and depositary lite requirements under AIFMD and UCITS V. Some clients like to use Société Générale Security Services (SGSS) as custodian – and possibly also as depositary – but there is certainly no obligation to do so, and some prefer to go elsewhere.
Newedge is also keeping an eye on AIFMD regulatory reporting as firms submit reports for the first time. In the capital introduction space, there have been panics about AIFMD making marketing impossible. Here Newedge had a swift and pragmatic solution – it temporarily ceased its email distribution list and asked clients to re-register on an internet form. Outside the EU, Newedge has also been apprising clients of the special new requirements for marketing in Switzerland.
Robust capital ratios
Société Générale’s appetite to accelerate its equity prime business is also due in part to its financial strength. Says David Escoffier, CEO of Newedge and Deputy Head, Global Markets, SG, “SG deleveraged decisively and quickly after 2008, so has more room for manoeuvre.”
By early this year SG’s core tier one ratio was already at 10%, and it is steadily ticking up to 10.1% in the first quarter and 10.2% in the second. So SG is already above the minimum 8% required by Basel III rules in 2019, four years ahead of that deadline – which was last year pushed out from the original 2015 to allow some banks more time to meet the standard.
This positions Société Générale well in a world where capital and liquidity are becoming increasingly scarce resources. Escoffier adds, “The traditional equity prime heavyweights cannot sustain their current level of activity, notably with regard to secured financing; it is just too expensive under the new Basel regime. By way of contrast, our model does not carry significant fixed costs, we have balance sheet capacity, and as such we’re talking to funds across the AUM spectrum. We know – having partnered with many such clients over the years – that the multi-billion fund of tomorrow can be a 5 to 50 million fund today.”
Newedge is not expecting to become as omnipresent in equity prime brokerage as it is for CTAs immediately, as the top two players in equities are quite well entrenched. However, Crawford is confident that the enhanced offering will enable Newedge to climb the equity hedge size rankings. In European prime brokerage overall, Newedge appears to be number three – so could be a very real contender for number two before long.
“Our CTA and quant franchise remains core to the offering, and we continue to invest and innovate here,” says Crawford. “It’s good to see many traditional trend-following CTAs enjoying a performance resurgence in 2014, with some CTAs back above high-water mark. Augmenting this core activity with SG’s significant capabilities means that we can take the natural next step and expand our equity prime business. In summary, we’re perfectly placed and the timing is right to realize the opportunities presented by a changing marketplace.”