Warning to Accountants & Consultants: Prime brokerages are trying to eat your lunch

15 January 2008

The Financial Times had an interesting special report yesterday on the prime brokerage industry.  These brokerages have traditionally made the bulk of their revenues from two sources: ”borrow fees” associated lending stocks to short-sellers (see related posting) and interest charges on the leverage used by hedge funds.  But as we’ve discussed on these pages before, the famously opaque stock-lending business is quickly being brought out into the daylight (see related posting).  The danger, of course, is that the lucrative fees earned by the prime brokerages will come under pressure at some point. 

Rather than sitting around and waiting for the day when there is a fully transparent market for short-selling, it seems many of the world’s prime brokerages are expanding into new revenue streams now.  This isn’t entirely new, of course.  Prime brokerages have long nurtured start-up hedge funds in an effort to bring into being their future clients (see related postings).  But this time, things are different. According to the FT, 

“There has been a shift from short-term, transaction-oriented relationships [between prime brokerages and their clients] to long-term, service-oriented relationships…Indeed, prime brokerage added-value services have tended to focus on helping start-ups to get off the ground operationally. Finding offices and choosing hardware and software systems are the staple of this model. But, with many hedge funds expanding rapidly, there is a gap in the market for more strategic services, particularly to established funds.”

The hedge fund industry has a pretty simple structure really.  Devoid of the distribution and marketing trappings of its mutual fund cousin, the hedge fund industry boils down to an artist (the fund manager), his business manager (the ops head), his agent (the marketer) and a small cadre of service providers (an accountant, a lawyer, a landlord, an administrator, a prime broker, and a data provider).  Occasionally, a hedge fund might engage the services of an outside consultant (a head-hunter, a business consultant etc.). 

So it appears that the prime brokers are fashioning themselves as a sort of turn-key hedge fund industry - able to provide everything but the fund management itself.  This puts them in direct competition, as the FT points out, with such apparently disparate firms as PwC and McKinsey.  Says the FT,

“Citigroup, for example, now offers what management consultants like to call ‘change management’ services. Linda Prager, head of Citi’s Prime Financial Business Consulting, says: ‘We operate like a management consultant team. We have formal consulting qualifications and we compete for business with the likes of McKinsey rather than with prime brokers.’”  

The big question will be how scalable are these ancillary services?  The prime brokerage business is relatively concentrated since it’s highly scalable (see related posting).  But can the world’s largest players translate this dominance into businesses requiring largely customized services?

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One Response to “Warning to Accountants & Consultants: Prime brokerages are trying to eat your lunch”

1. Wednesday links: perverse incentives « Abnormal Returns Says:
   January 16th, 2008 at 12:04 pm

   […] “So it appears that the prime brokers are fashioning themselves as a sort of turn-key hedge fund industry - able to provide everything but the fund management itself.” (All About Alpha) […]