Archegos Capital Management. Three words likely to chill the blood of prime brokers after the collapse of the family office last year blew a $10 billion hole in the balance sheets of Credit Suisse, Nomura, Morgan Stanley, UBS and others.
But not all prime brokers suffered in 2021. Barclays ended the third quarter with record hedge fund flows in its prime services division, powering revenues for the firm’s equity division to an all-time high. The UK bank hoovered up $20 billion in balances from former hedge fund clients of Deutsche Bank, which exited prime brokerage in 2019, and additional business from Credit Suisse following its November decision to quit prime services.
“The market events this year have accelerated some of these opportunities and increased the value proposition of our offerings,” says David Lohuis, global head of prime services at Barclays.
But seeing an opportunity is different from being able to take advantage of it. Here, Barclays’ performance hinges on three factors: integration, technology and selectivity.
All the elements of the bank’s prime brokerage business – execution, financing, clearing and direct market access – in equities and fixed income are centralised under one leadership across all regions.
That extends to risk management: the bank’s global netting agreement (GNA) platform provides dynamic cross-product margining across stocks, bonds, futures and over-the-counter derivatives.
Trade execution takes place on Barclays’ low-latency ePrime platform, which allows the bank to internalise and offset funding transactions, reducing risk and capital requirements.
And the bank heavily scrutinises prospective clients so it can be comfortable with the risks it’s taking. A 360-degree view of its client base has helped the bank dodge the bullets of Archegos and the like.
This three-pronged strategy has enabled Barclays to grab a bigger slice of the market as hedge funds have become more systematic and multi-strategy. The bank has increased its prime broking revenues by an average 11% each year since 2016. Over that time, it has risen from ninth to become the fifth largest prime broker by revenues as of the end of the third quarter, according to industry monitor Coalition, where it also ranks as the top non-US prime broker.
One US hedge fund says Barclays is “integrated in the bulk of what we do… From direct market access, cash and futures, it all sits under one financing house. This means Barclays has the knowledge and can understand our risk profile better.”
Integrating risk management
The Archegos affair provided a graphic example of what can go wrong when prime brokers handle risk poorly. Credit Suisse’s $5.5 billion loss – the biggest of any single counterparty to the family office – owed much to its crude margining models, geographical and product silos, lack of accountability among senior managers, and a business culture that put revenue before risk.
Barclays has avoided these bear traps.
The bank aims to be the most integrated prime broker on the Street, according to Mike Webb, head of equity finance: “That’s across execution, financing and clearing in US, Europe, and Asia, both in fixed income and equities.” All activity is centralised under one leadership – David Lohuis – with a culture of collaboration rather than product silos.
That integration is backed by technology in the form of the ePrime platform on the execution side and GNA for risk management.
“What ePrime is at its core is to put technology and data and transparency at the centre of optimising a reasonably complex intersection between clients,” explains Webb. “Being completely integrated across product services and regions and focusing on technology to help those hedge funds extract financing alpha, has been the core guiding principle of our plan.”
Barclays’ ethos of integration is embedded in how it views risk. This way of thinking led to the creation of its GNA platform, a global, cross-product margin platform that allows the bank to view its clients’ risk profile in the round. GNA uses a dynamic – rather than static – margin model, which means the prime broker can require more collateral if the underlying risk of the position or account increases due to volatility.
We employ an integrated and dynamic risk management approach, which aims to understand and to manage the risk lifecycle from client onboarding to a potential liquidation of exposures every daySergey Gerasimov, Barclays
“We’re very conscious of the risks of losing money from prime finance, and that risk is at a peak when leverage and exposure concentrations are high and liquidity is very scarce,” says Sergey Gerasimov, who oversees Barclays’ global prime services risk management.
“Therefore, we employ an integrated and dynamic risk management approach, which aims to understand and to manage the risk lifecycle from client onboarding to a potential liquidation of exposures every day. This is carried out continuously within the front office, as well as in collaboration with colleagues in credit risk, legal and compliance,” he adds.
The bank’s dynamic margin methodologies, which are calibrated on the GNA system, are applied across all segments of the prime brokerage division to account for liquidity, concentrations and directionality across various risk factors. The bank relied heavily on the system in March 2020 when global markets tanked and margin calls skyrocketed at the height of the coronavirus pandemic.
By aggregating all of its prime brokerage risk across futures, OTC derivatives, equities and fixed income, the bank has a picture of counterparties’ liquidity and can respond to market changes intraday.
GNA also takes into account a range of product agreements, such as the Isda master agreement for derivatives, as well as contracts for prime brokerage financing, repo, futures and stock loans.
“You need to have a product that provides a legal framework, as well as technological framework, that is capable of pulling it together during the stress times,” Gerasimov says.
This framework enables the bank to develop a margin methodology for similar products. If a hedge fund trades interest rate futures and repo, for example, Barclays can tailor a margin methodology that takes into account rate risks. “That margin methodology is calibrated to a specific tail loss and it changes every day, depending on the portfolio construction or the end portfolio that we receive from our clients on a daily basis,” Gerasimov adds.
Choosy over partners
Part of the reason Barclays is able to maintain such an intimate view of its clients’ risk is that it is fussy over who it does business with. Its client base is small compared with the largest prime brokers: Morgan Stanley, for example, had 3,436 single-name hedge fund clients in September 2021, data from Preqin shows. Barclays had 717, up from 587 at the end of 2019.
This cosy client roster is a deliberate decision to prioritise quality over quantity. Barclays aims to cultivate close client relationships that can withstand the test of choppy markets.
“It’s incredibly important to know your client. It means at times of stress, you have to have that connectivity to the CFO, treasurer or COO [of the hedge fund] and making sure that dialogue and communication is consistent and thoughtful around the way you manage those relationships,” Lohuis says.
The due diligence process at Barclays is rigorous: executives from prime, credit risk, legal and compliance each run the rule over prospective hedge fund clients. The control function has an independent veto power over a new client if it doesn’t meet their risk parameters. This level of selectivity helps the bank safeguard the stability of the wider platform.
Barclays’ management of risk in prime brokerage has received plaudits from clients, not only for ensuring a stable partnership but also for generating a better outcome for both sides. “They [Barclays] get a full picture of our business and have come to some great outcomes on how the business is margined on an aggregate basis across equities and fixed income. They are fantastic,” says one client.
Another hedge fund client says the Barclays risk team understands the prime brokerage product better than most other providers, and because of this they can gain better financing.
When it comes to decisions on funding, the buck stops with Gerasimov as risk management head. He sets the mandate for Barclays’ funding capacity across regions, giving clients a clear view of the bank’s risk management and its funding appetite.
This means there is often strong collaboration between the prime brokerage desk and clients on margin decisions – something that was significantly absent within Credit Suisse during the Archegos debacle.
Webb says: “We take on counterparty risk, liquidity risk and market risk and it’s the responsibility of the leaders in this business to own that risk. I think where some primes have gone wrong over the years is where risk was outsourced to a control function. Our view is we own it, and we own it in close collaboration.”
Electronifying prime brokerage
Better risk management and closer integration of products and services are two prongs of the firm’s prime proposition. The third is technology – a key factor in what Barclays sees as an algorithmic revolution in prime brokerage.
Consolidation within the hedge fund industry means the big are getting bigger, while multi-strategy investment techniques are becoming more widespread. This poses a challenge to prime brokers which, in the past, provided financing based on category of assets within a siloed infrastructure.
As other areas of global markets have become electronified, attention has turned to making financing more efficient. One way is through internalisation. For example, by matching one client’s long with another client’s short on stock names, the prime broker reduces overall risk and creates capital savings that can be passed on through funding axes and more competitive pricing.
Where Barclays feels it can differentiate is through the electronification of the process through the ePrime platform. “Of all the prime brokers willing to offset these balance sheet trades, Barclays’ solution is the most well thought out and best defined,” another client comments.
Though its investments in technology and its ability to offset trades, Barclays says its clients will be incentivised to supply inventory sought after by other clients in order to achieve differentiated pricing.
“Clients are going to achieve [financing alpha] by being more methodical as to which securities they place with which prime broker, and that will result in more attractive financing,” Webb says.
Webb believes prime brokers that can provide more transparency in the financing process will be best placed to win market share. “There is going to be a more democratised allocation of the wallet based on trust and transparent data around returns. We think as this market matures and technology starts to drive an increasingly large part in the allocation decisions of clients, that’s levelling the playing field and should create disruption,” he says.
In addition to providing optimised financing, Barclays has integrated low latency trading and execution with its direct market access (DMA) capabilities under the ePrime roof across cash and derivatives, equities and fixed income. This has enabled the bank to capture more technology-focused and quantitative fund managers, as well as other multi-strat/macro funds that require cross-product financing and DMA.
Webb says the bank is also looking to add long/short and real money equity funds to its list of prime broking clients.
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