GAIM: RBS remains committed to prime brokerage

Prime Brokerage
17 Jun, 2014

The Royal Bank of Scotland (RBS) remains committed to its prime services business despite plans to scale back on its rates prime broking and over-the-counter (OTC) clearing units.

RBS Prime Services focus predominantly on FX and futures. Nonetheless, there are concerns among some experts about the viability of prime brokerage at the state-backed bank. One service provider pointed out that the government’s efforts to curb the investment banking arm at RBS could facilitate the demise of its prime services unit. Such an event would require fund managers to port business elsewhere to other prime brokers.

However, the bank has got its supporters. “It would not be in anyone’s interest for RBS to ditch prime brokerage. It is unlikely the government would force the bank to cut back its prime brokerage business. Furthermore, if the bank went private once again, prime services would continue. It makes no difference,” said one industry insider, speaking at GAIM in Monte Carlo, of which RBS is a major sponsor.

One hedge fund manager, who did not use RBS as a prime broker, said he would not have any issue with utilising them. “If there was a problem, we could simply port business to another provider,” he said. He added the bank did not pose a serious counterparty risk as it was backed by the British government. However, it is highly unlikely RBS would use this argument in any pitch.

Others point out that while RBS suffers from legacy issues as a result of its government bail-out in 2008, investment banking as a whole is an industry confronting huge challenges. “All of the major banks have got problems, not just RBS,” said one expert.

The prime brokerage model more broadly is facing enormous tests. Firstly, hedge fund financing is being tightened up by prime brokers. A J.P. Morgan white paper in 2014 said attempts by prime brokers to reduce their dependency on short-term funding, hedge fund and investor restrictions on re-hypothecation of collateral and Basel III capital requirements, were all going to lead to an increase in the cost of financing. There is also a be strong possibility regulators in Europe could clamp-down on re-hypothecation whereby they will impose a 140% cap similar to that of the Securities and Exchange Commission (SEC).

Analysis in 2013 by Barclays Prime Services said managers would need to rationalise their borrowing practices, revisit appetite for leverage and reset their return on equity expectations to deal with the rising financing costs. The Barclays study added managers running illiquid strategies would be particularly hard-hit by the changes as prime brokers will be less willing to lend out illiquid assets due to the Basel III requirements on liquidity buffers. Prime brokers will therefore have to incur a portion of the cost of maintaining these buffers with their share of short-term, less liquid liabilities.

Highly leveraged managers will also be impacted as these strategies tend to be reliant on access to less liquid financing. Barclays calculated these changes would lead to the average hedge funds’ returns declining by 10 to 20 basis points. Fixed income arbitrage – one of the most leveraged strategies at 13 times NAV – would be hurt the most by the changes with returns falling anywhere between 40 and 80 basis points, said Barclays.

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