The Rise of the Independent Prime Broker

The post-COVID market has dealt a host of challenges to many on Wall Street. Stubborn inflation, an aggressive Fed, compressing profitability, and changing volatility patterns across asset classes — all underpinned by geopolitical concerns — have banks keeping a close eye on the state of their balance sheets. As a result, Common Tier 1 (CET1) Capital ratios are falling, driven by increasing Risk Weighted Assets (RWAs), further tightening the supply of capital available for facilitating loans and trading (i).

More than a Bank Function

Today’s large banks are a collection of so many businesses that it is easy to forget that investment banking, retail wealth management, trading, wholesale banking, and prime brokerage are all housed under one roof. From the vantage point of any one client segment, the balance sheets of large banks are a complex array of products that seem far removed from their business and capital needs. Capital, already scarce, is in demand by each of the businesses that make up the bank. Similarly, every business needs investment to modernize processes, data access, infrastructure, and technology.

In the face of tightening capital, banks are taking two distinct paths in prime brokerage and risk financing businesses:

• Shutter the business
• Maintain the businesses with minimal investment

The first path creates a situation where scarce capital is allocated to the choicest institutional clients with strategies that fit into the bank’s risk perspective. These clients have the resources to invest in data, insight, and technology. They can see their risk in real-time, model the risk and collateral models of their prime brokers, and make do with their prime’s offerings. The other option is to cut and run, and there have already been numerous shut downs of prime brokerage businesses.

Emerging managers, active strategies, and strategies with demanding data, lower profitability, or technological needs are unsupported by the big banks, and often asked to leave. Large bank-owned primes are already off-boarding these clients as they look at current conditions and anticipate even higher capital requirements in the coming year (ii).

A Shrinking Landscape

As such, smaller hedge funds, family offices, and RIAs have to face these challenges on their own. This cycle has played out repeatedly since the current capital regime began in the wake of the 2008 financial crisis, and we’re seeing it again today.

These funds can look to non-bank providers to diversify counterparties and execute riskier trading strategies. For larger hedge funds, this means expanding their roster to include non-bank and independent prime brokers. Smaller funds should consider independent primes when making their first prime choice or expanding to a second prime.

The challenge is, the non-bank prime brokerage industry is tightening, and options are limited for non-bank, independent balance sheet access. Many independent primes have been acquired, and other smaller prime brokers are starting to introduce brokers for bank capital (ii). As bank capital becomes more scarce, the alternatives to that capital are growing scarce as well. Faced with fewer options, funds should look for a prime broker that is set up for growth and that is invested in its clients global business.

The Startup Taking on Prime Brokerage

As an independent, non-bank prime, Clear Street supports the prime services and funding needs of an ever-growing roster of hedge fund, family office, and RIA clients with its capital base. Clear Street’s award-winning client service focuses on working closely with clients to understand and address their pain points.

Founded in 2018 by industry veterans, Clear Street is investing heavily in modern tools that solve the industry’s most neglected problem: legacy technology. Clear Street has built a proprietary, cloud-native, clearing and custody system to replace the legacy infrastructure used across capital markets, improving speed, access, and service for its clients. The firm’s goal is to give all market participants, from emerging managers to large institutions, the tools and services they need to compete in today’s fast-paced markets.