Amid paltry profitability and escalating regulation, some prime brokers are reportedly reining in and off-boarding hedge funds – as well as closing some divisions. Societe Generale Prime Services (Prime Services), on the other hand, is confidently talking to selected funds of all sizes.
Societe Generale (Soc Gen) has invested heavily in fully acquiring and integrating Prime Services, and is focusing on the prime brokerage business, which continuesto enhance its franchise with recent minority stakes such as GMEX and ERIS. As capacity contracts elsewhere, and while industry assets reach new records, a vacuum is opening up – and the emboldened Prime Services is a credible alternative (or complement) to the largest incumbents.
Prime Services is building on the foundations laid by Newedge, with synergies from Societe Generale particularly valuable on the equity side. The Hedge Fund Journal met with four of the senior management, at Prime Services Bishops Square offices in London’s financial district, to hear how the integration benefits clients, and what Soc Gen’s ambitions are for the new entity.
Prime Services has two overarching global co-heads – one from the old Newedge and one from Soc Gen. Chris Topple worked in a variety of prime brokerage sales roles since 1993, at J.P. Morgan and Nomura/Lehman, before joining Newedge in 2010. Christophe Lattuada has been with Soc Gen since 2009, as head of strategy and corporate development, before which he was at Boston Consulting Group in Paris. Topple had headed the Newedge prime brokerage business and has, from that angle, integrated it into Prime Services, which sits inside the wider Soc Gen platform i.e., Soc Gen’s “Global Banking and Investor Solutions” segment, where Lattuada had run strategy and overseen the merger.
Different divisions of Prime Services also have global heads, and THFJ heard insights from two who have spent most of their careers at Soc Gen: Global Head of Cross Asset Secured Financing, James Treseler, and Global Head of Global Execution Services, Francois Banneville.
Treseler has spent 18 years with Soc Gen, mostly in New York, and he manages and engineers multiple financing solutions, including security borrowing, across all asset classes. Banneville has first-hand knowledge of hedge fund strategies: he started out trading volatility arbitrage and index arbitrage, and then moved to brokerage, co-heading cash equity and execution services. Banneville joined Prime Services to take charge of cross-asset execution and runs a team of 150, including desks in the US, Asia and Europe, covering all asset classes. Prime Services recently won THFJ’s 2015 award for “Best Global Multi Asset Prime Brokerage.”
An integrated business model by design
This integrated business model was not a coincidence of the merger – but a conscious decision arrived at after Soc Gen explored and analysed several possible business models for prime brokerage. They looked at the (Morgan Stanley or Credit Suisse) model of being part of equities, and looked at the (J.P. Morgan or HSBC) model of being aligned with custody. “But we determined that an independent group within capital markets housing multiple divisions under one roof was the right way to go,” says Topple. For instance Prime Services now has a very strong equity finance and equity derivatives offering, with abundant inventory, including hard to borrow securities, managed by Treseler, within Prime Services. Banneville brings in the DNA of algorithmic and bespoke execution, which is constantly advancing as he drives multiple research projects. And the legacy FCM, OTC clearing, fixed-income prime brokerage, FX prime brokerage, cash equities and synthetic equites, are all coherently united. All of the team constantly stress that Prime Services is truly a cross-asset offering.
The multi-asset blueprint has multiple rationales. “Organizing the unit under one roof allows for aggregation of risk and optimizing of collateral, all in the same legal entity, which permits cross-margining across all asset classes,” elaborates Topple. Even pre-Prime Services, Newedge was renowned for holistic cross-margining, across markets, instruments and venues, which afforded funds capital efficiencies in terms of lower margin requirements.
Topple adds that itis “operationally easier to settle one margin call rather than multiple ones and to have one statement summarising all exposures in one place.” On top of this are the advantages of versatile financing options – swaps, security loans, margin lending, repoes, synthetic financing (eg CFDs and TRS) and collateral management solutions– also all on the same menu, so that funds can do cash and synthetic trades interfacing with one desk. “Executing, settling and financing trades in one place gives immense operational efficiency” is what Topple hears from clients.
Prime Services is all about building something bigger where the whole is greater than the sum of the parts. It is a great fit with each side dovetailing the other in a complementary way. “Soc Gen did not have prime services, OTC clearing, or an FCM for downstream product servicing, but it did have great cash equities connectivity,” summarizes Topple.
This is crucial. Although Prime Services is very committed to maintaining Newedge’s high rankings for macro and CTAs, Soc Gen has pragmatically recognized that the majority of global $3 trillion (and counting) hedge fund assets are now made up of equity-oriented strategies – and has resolved to create a prime broker that is now a serious contender in competing with the big US investment banks for the largest mandates. Topple admits that Newedge’s focus on CTA and global macro was born of necessity as “the Newedge entity was smaller in terms of balance sheet and capital and so lacked the inventory of borrowable securities needed to target a large market share of equity long short managers;” though Newedge has serviced some equity hedge funds for 15 years. Now “We are evolving not building a prime brokerage,” says Topple.
This is perhaps because starting a prime broker from scratch would be a gigantic undertaking. It always seems anomalous that Soc Gen was for so long one of the only major banks without its own prime brokerage. Now Soc Gen has seized what Banneville views as “a rare opportunity to merge with a partner that was already number one in many areas, bringing a lot of credibility to the table.”
Integration fosters client focus
Although the acquisition was only completed in May 2014 the practical aspects of the merger have been accomplished. “If you talk to the teams the integration is over,” says Topple. It is already complete in terms of project management, spending and synergies, and the rebranding is virtually done with the Newedge brand name now only remaining on some CTA and other performance indices. Notwithstanding the jettisoning of this moniker, Topple reflects that “it is important that Newedge was not cut up. The core of Newedge forms the core of Prime Services.”
With the erstwhile management consultant’s eye for detail, Lattuada admits that there is some paperwork to do in terms of collapsing legal structures but that should not take more than 12 months. This is a relief as Topple discloses that “clients always had questions about the dual ownership structure of Newedge and now there is clarity.”
Explaining the transition Lattuada says, “we have gone from being an independent company with two shareholders, to a fully integrated business line within capital markets. All of the building blocks of a prime services offering have been assembled from a legal and management perspective.” Lattuada underscores the breadth of the integration by enumerating that private banking, security services, advisory, collateral management and OTC clearing services all sit in the same Global Banking and Investor Services division as does post-trade services. “This is all part of the value chain as it is easier to operate these services as part of the same group,” he says. The model pulls together “prime services, agency lending and other service providers for hedge funds, asset managers and clients from security services.”
Echoes Banneville “clients feel they are dealing only with one company and the quality and intensity of service is the same across the spectrum.” Treseler agrees “it was a natural marriage with derivatives, execution and prime brokerage all meeting together now.” He also concurs that the group’s focus is now more streamlined. “We previously acted as a prime of primes for over a decade with our largest client being the derivatives group of Soc Gen. Now we provide the services externally with pure client focus catering for hedge funds and asset managers.”
Balance sheet strength
Prime Services is also confident about the financial strength of its parent. According to Treseler, raw and crude leverage ratios are becoming de-emphasized. Instead analysts look at liquidity metrics emphasized by Basel III, ranging from liquidity capital ratios (LCR), to short-term financing and long-term financing, as well as the Net Stable Funding Ratio (NSFR). The LCR and NSFR are a double whammy for many prime brokers: the former forces them to hold more very liquid assets to meet potential 30 day outflows while the latter will, probably from 2018, push their own funding further out to match the maturity of assets. Regulators are concerned about systemic risk and liquidity mismatches. The new rules restrict maturity transformation, which is a fundamental function of banking, and mean banks are both earning less on assets and paying more for capital, particularly for secured funding – making it costlier for prime brokers to finance hedge funds.
Post-crisis, the focus on asset segregation has also made re-hypothecation a less important part of the prime brokerage business model and “there is far less leverage in the system,” says Topple. The vast majority of investment fund assets are not now being re-hypothecated, i.e., used to support further lending. Treseler thinks that of €17.5 trillion of assets in worldwide investment funds, only €1.7 trillion is in fact being lent out – and some €900 million of that is only being repoed against other assets, so is not truly contributing to credit creation. Pre-crisis, IMF reports suggest at least $4.5 trillion was being re-hypothecated in late 2007.
Though these regulatory constraints make life harder, some banks are adapting and Soc Gen boasts an LCR 121% in 1H 2015 up from 118% in 2014: this is already well above the minimum of 100% that should apply by 2019, suggesting that Prime Services has already aligned its model with the new regulatory realities. Indeed Topple claims that “the repricing of prime brokerage financing has already happened.”
Treseler says “if you look at the product cycle we are only in adolescence and we have plenty of liquidity for onboarding funds.” This is seconded by Lattuada who assures us “Soc Gen is redirecting resources towards us now, and has given all the resources we need to develop the business.” Soc Gen paid €275 million for the half of Newedge it did not already own, as part of an asset swap with Credit Agricole. In addition Soc Gen has invested “significantly in integration,” illustrates Topple. Since then Soc Gen has also invested in bolt-on acquisitions such as part of Jefferies Bache and has taken minority stakes in GMEX and ERIS.
Derivatives and synthetics
A strong balance sheet helps to support derivatives. US national Treseler has become something of a Francophile during his time at Soc Gen, spending a year working in Paris, and he proclaims “the French do four things well: wine, cheese, dessert – and Math!” The last of these may help to explain why SocGen has been “the world’s leading derivatives house for several years, as after all synthetic prime brokerage is simply a derivative.”
Synthetic trades are growing in popularity, as they are less capital intensive. “If you borrow a security it is on your balance sheet whereas a synthetic total return swap is off balance sheet,” explains Treseler. But some big funds insist on doing everything synthetically for another reason – to avoid possible future transaction taxes. Those in France and Italy are already a fact of life, while UK and Hong Kong stamp duty have existed for decades. The real fear is that the US might one day try to introduce transaction taxes, and while Prime Services is lobbying against this, synthetic trades are perceived as a bulwark against FTTs.
Shooting for top five status
So what more precisely are Prime Services ambitions? Already one of the largest five prime brokers in Europe, it aspires to top-five status globally in two ways. Long-term Prime Services wants to become one of the top-five prime brokers globally. Short-term it wants to join the top-five roster of prime brokers servicing the biggest equity funds.
“We were already a top-10 prime broker according to Coalition Analytics, and are now competing head to head with the big five for mandates on a daily basis,” states Topple. His ambitions are tempered by some realism – “it will take time as they have been doing it for 25 years so we won’t overtake them any time soon, but we can certainly compete for future mandates head-to-head and win our share.” he concedes.
Right now, Prime Services is more likely to be the lead broker for smaller and medium-sized firms (defined as assets between €50 million and €500 million) but is quite content to be the number two, three, four or even five broker for the largest funds. The new departure here is that Prime Services is now relevant to all three segments – small, medium and large – and five years ago Topple did not expect to be relevant to the very biggest. He is delighted to be receiving reverse enquiries from some of the largest funds who are frustrated by capacity constraints – and willing to pay up for balance sheet. Topple will not name names as clients seldom publicize switches or additions of prime brokers, but it seems that Prime Services is developing a critical mass in terms of its client base in equities, event driven and credit. Prime Services services over 1,000 hedge fund strategies and quarterly results from Soc Gen keep mentioning strong on-boarding. “Clients are listening to the story we have to tell,” says Topple and apparently 10 new salespeople are also purring that “it’s nice to be on the front foot not the back foot.”
Banneville stresses that Prime Services relationship with hedge funds “goes well beyond prime services, into equity, fixed income, derivatives and structured products” all of which provide more added value for the client – and more potential revenue sources for Prime Services. The essential reason for the diverse Prime Services business model is simply the economics of the business. Compounding the regulatory squeezes on capital and liquidity, competitive pressures on commissions and dealing spreads, not to mention central banks flattening interest rate spreads, means many of the individual services would not be commercially viable on a standalone basis! Lattuada explains how all parts of the business have a common P&L, and how Prime Services looks at the overall relationship when deciding whether to take on new clients. The integration of Prime Services removes the need for the bureaucratic discussions about how one unit can cross-subsidize another that take place in more demarcated organizations.
The integrated formula seems to be working as Prime Services saw four quarters of steady, sequential growth in Net Banking Income (NBI) after acquiring Newedge. In 2014 this grew from €101 million in the second quarter of 2014, to €117 million in the fourth and first quarter 2015 results unveiled a further 25.1% increase in to €144 million; this has stabilized at €142 million in the second quarter. If the €353 million contribution to Soc Gen Net Income from Prime Services in 2014 seems a small fraction of Soc Gen profits, remember that Prime Services is also feeding other units – the Global Markets and Investor Services umbrella, including fixed income, credit and commodities, and security services, made €5.628 billion in 2014. And at the group level, Soc Gen’s second quarter 2015 results beat consensus forecasts with a 25.1% growth in net income.
A scalable and growing business
Integrating Newedge into Prime Services is not the end of the acquisition trail. The recent purchase of selected assets from the Jefferies Bache commodity broking business, was not a massive acquisition (no price was disclosed) but was significant – as nearly 300 clients have migrated over to Prime Services for clearing and execution and “we very much have the resources and bandwidth to service them,” Lattuada says. This bolt-on buy comes only months after Prime Services bought a financial, industrial, and metals portfolio from Barclays. Jefferies and Barclays are only the latest banks to have exited commodity broking because lower commissions and higher capital requirements make it a less lucrative business. Deutsche Bank also got out of commodities in 2013 while JP Morgan and Morgan Stanley have reduced their exposure; UBS exited fixed income back in 2012. In August 2015 Credit Suisse exited FX prime brokerage, as did Dutch bank Rabobank in 2014, while both SEB and Morgan Stanley have reportedly scaled back their FX businesses.
But Soc Gen is committed to prime brokerage for the long haul so divisions that could be dismissed as marginal distractions by some banks, can be incrementally valuable to Soc Gen. This is partly because Prime Services has invested in automation that makes the business model hugely scalable. “We clear 3 billion contracts, a year, STP (straight through process) them, and 99.4% of them are not touched by a human hand,” illustrates Topple, who explains that this powerful factory of infrastructure was created to service quant funds. So the Jefferies Bache acquisition, which added about 5% to Prime Services volumes, sounds like a continental breakfast – it was “easily onboarded with no extra capacity required,” Topple is proud to tell.
Accessing markets and liquidity
Prime Services is also spreading its wings into more global markets, particularly equities. It already has access to over 130 markets but is constantly on the lookout for new execution venues, such as GMEX Group and ERIS Exchange, which offer instruments including various swap futures. Very soon the Shanghai–Hong Kong Stock Connect will allow Prime Services to do equity derivatives in Hong Kong with India and China next in line. “This is all part of our seamless service of servicing clients’ clearing, financing and execution needs across the asset class spectrum,” says Banneville.
The Newedge heritage is not forgotten, and Topple reckons Prime Services remains the default choice for CTAs, owing to its very large market share of 11% on the listed derivatives side. Topple says “Our core client base was CTAs and they want to access markets from South African wheat to Tocom rubber – and they need that connectivity.” He goes on “Our very strong CTA franchise is very important and we hope to be thought leaders in the sector but equities are the bigger growth driver.”
But equities are not the only area Prime Services is adding coverage. So far the expansion of Prime Services clearing investment universe (already interest rates, CDS and FX have been added) has been driven by client demand. Clearing and liquidity is concentrated on ICE, CME, LCH and Eurex, where Prime Services has memberships of all major CCPs, and is actively clearing. Prime Services cleared the first Brazilian Real NDF in May. Topple thinks “the next area could be Asia where we don’t clear OTC yet as there is not yet much demand.” He thinks the biggest users of clearing are hedging “We have always been a factory for clearing and view OTC clearing defensively to protect our listed derivatives franchize.” As with other offerings, OTC clearing needs to be part of a wider service, including execution, listed derivatives and multi-asset portfolios – as it is simply not profitable enough to do clearing alone. Once again, a rationale for the integrated business model.
This scale and bandwidth of market presence matter more than ever simply because “a bigger market share can tap into more liquidity,” argues Banneville and in particular he claims “when the derivatives roll comes along you can save on execution costs and market impact.” In cash equities, crossing networks are becoming very important as participants can trade directly with each other, cutting out the middleman to cross trades at the mid and avoid paying the bid-offer spread (or sometimes even capture the spread!).
Concerns about liquidity might be most acute in credit markets, where Banneville observes the diminution of market making activity has dried up corporate bond liquidity – “so it’s no surprise clients go to the broker with the biggest market,” he says. Banneville thinks Prime Services is already strong in European high yield but it is also striving to improve “We are working with clients and technology providers on initiatives to bring liquidity to the asset class.”
The quest for execution efficiency aims to eke out extra returns, and Banneville regularly gets “client feedback that every fraction of a basis point counts, particularly for portfolios with higher turnover.” Low latency DMA, care and voice execution are on offer and Soc Gen’s liquidity-seeking algorithms are especially popular in fragmented marketplaces like equities under MiFID I. But now Banneville finds “clients are coming for bespoke services and want execution tailored to their investment style.” This is not a problem for Prime Services. For instance “if a client trades liquid mid-cap stocks, Soc Gen needs to be a liquidity provider and avoid being negatively selected by market makers,” Banneville reveals that currently Prime Services is busy working on six or seven large execution projects for specific clients. These range from options to Japanese equities, and from machine learning to strategies with high average daily volumes on the CME Group. “These research partnerships make relationships more interesting – and more sticky,” says Banneville.
MiFID II will create more obligations around execution and Banneville is already geared up for this with pre-trade and post-trade capture both part of the STP (Straight Through Processing) process. He explains “Orders can be received manually, by voice, or electronically but swift and consistent communication speeds up processing, which is essential to gauge best execution as MiFID II comes in,” Banneville also claims that Prime Services is more efficient than its competitors in terms of trade processing speeds.
Topple reflects that “Prime Services is no longer an agency broker as Newedge was, but thanks to the segregation of the prime services unit the same mind-set continues,” and Banneville’s research projects would appear to back this up. He sums up his approach as “we tailor solutions, including execution solutions, to clients, and this is one of the advantages our clients enjoy.”
Versatile financing and collateral options
Market access and efficient execution are of no use if financing and margining are prohibitively costly, or unavailable, and this is another advantage of integration. Prime Services will not finance every portfolio and Treseler makes no bones about his client selection criteria. “The first risk is credit risk of clients – then we look at assets,” he explains. But when it comes to collateral financing, Prime Services does offer three broad models and Treseler says this “makes him feel like a general practitioner as clients don’t know they have problems until we tell them about it!”
First, securities financing is the traditional prime brokerage model, which at Prime Services encompasses cash, repo, reverse repo and synthetic financing, and sources security borrow internally and externally. Second, client collateral management has become an advisory business revolving around the Treasury group. “We transform collateral for funds, clearers and exchanges, taking collateral from all corners of the world and transforming it to optimize returns.” Treseler finds this offering is perceived as an alternative to the US triparty banks. The third collateral solution is the agency lending business – which both lends out collateral on behalf of beneficial owners and takes in the collateral from third parties. In both cases collateral will only be lent to approved borrowers, and in all cases bespoke solutions can be crafted.
Topple adds that the versatility of the collateral offering helps Prime Services to cater for a broad array of clients and not just hedge funds. “We also deal with pension funds where they need eligible collateral for clearing; long-only managers who want to enhance returns through security lending, as well as hedge funds that need equity finance.” All of these client types expand the pool of assets over which Prime Services can spread its fixed costs.
Regulatory change for clearing and collateral
Collateral and clearing are regulatory changes that force Prime Services and its clients to change how they do business. For the time being OTC trading in Europe can be more capital efficient than clearing and some pension funds such as Europe’s largest, APG, have lobbied against mandatory clearing as they are loathe to put up more collateral. But the luxury of very low or no initial margin on OTC trades only exists for those stronger or larger credits that can find a broker willing to trade with them. And here Topple fears smaller counterparts and hedge funds will struggle to find a bank to deal with – so they will need to find a CCP to access derivative markets. Although Prime Services is well established as an in OTC clearing, they see execution moving to SEFs or listed OTC contracts and want to be part of it. “GMEX and ERIS are credible partners,” says Topple, pointing out that Deutsche Boerse was the first minority investor into GMEX.
When clearing becomes mandatory under EMIR – or perhaps just the only route for some participants – margin requirements could rise in Europe. Witness in the US the amount of collateral needed has gone up by a factor of 10, 15 or 20. To help accommodate this, Prime Services “takes ineligible collateral and transforms it into collateral accepted by exchanges, rather than using cash and liquidity,” says Treseler, and this type of service could become vital if collateral shortages develop in Europe. In this area Soc Gen’s outsourced collateral management solution, TEMPO, can help clients – and is a synergy between Prime Services and Societe Generale Security Services. “It is difficult to put a number on the savings but in a zero rate climate – or even negativerate environment – every basis point matters,” says Treseler. This healthy obsession with basis points seems to touch all aspects of Prime Services.
Another facet of clearing is the regulatory requirement for cleared, segregated client assets to be sitting on Soc Gen’s balance sheet – something that Soc Gen is perplexed by. “Segregated deposits should not be seen as assets of the bank when we cannot use, touch or re-hypothecate them,” argues Topple, which means the banks cannot use the deposits towards credit creation and generating extra returns. Topple thinks that the regulatory treatment of deposits is making it harder for smaller firms to find a provider and Soc Gen is lobbying for a change to the treatment of segregated deposits.
Research, thought leadership and capital introductions
Research and thought leadership activities are continuing unimpeded by regulation. The Prime Services equity research offering is mainly European for now, and has beefed up its coverage of the top performing pharmaceuticals sector in 2015. Prime Services may expand coverage into Asia through partnerships such as that with independent research provider Japan Invest in Asia. This was a contra deal that let Japan Invest access execution capabilities in return for distributing Soc Gen research. “Soc Gen is a leader if not the leader in macroeconomic and quantitative analysis,” says Topple who stresses “everything that is quant, including structured finance and equity derivatives, is in our DNA.”
The Alternative Investment Consulting unit produces commentary on trends, CTAs, equities, fund structures, UCITS, ’40 Act funds and managed account structures. Recently a thought leadership piece on “Life Outside of Trend” was published in THFJ, illustrating how CTAs are pursuing a variety of strategies besides traditional trend following.
Capital Introductions have changed since the crisis, as the glamorous parties of yesteryear have been superseded by the hard grind of due diligence. “We need to know almost as much about fund managers as do allocators,” says Topple, who stresses that he and the Global Head of Alternative Investment Consulting, James Skeggs, have to be relevant and on top of technical details to maintain their credibility with the world’s largest investors. Prime Services capital introduction events are now unashamedly exclusive. There is usually one event per quarter with equities held in March 2015 and commodities in June 2015, as well as educational workshops and roadshows. As few as four managers will present at events and several dozen hand-picked heavyweight investors will be invited. The award-winning Cap Intro team, led by Global Head of Hedge Fund Sales & Capital Introductions, Duncan Crawford, has staff in London, New York, Los Angeles, Chicago, UAE, Tokyo and Hong Kong, where Prime Services’s head of Asian capital introductions, Rebekah Pang, was selected as one of THFJ’s Leading 50 Women in Hedge Funds in the 2015 survey sponsored by EY.
As other players retreat, retrench and sometimes fall by the wayside, Prime Services is happy to act as a consolidator and its eclectic, integrated offering is appealing to a growing number of asset managers including hedge funds.