Analysis: Negative Rates Push Banks to Expand Prime Brokerage Units

At a time when margins are getting thinner, prime brokerage units of big banks could end up being expanded.

The bulk of news about big banks during the past couple of months can be summed up with one dreadful word: layoffs. As the profit margins of major lenders have continued to get thinner, a number of banks have committed to restructuring their operations and started trimming their costs related to employment.

Few have noticed that in between the lines, some prominent firms, particularly in Europe, where job cuts have been more material, have committed to expanding their prime brokerage businesses. At a time when negative interest rates have been hurting big banks and excess costs have come into focus, top executives are realizing that prime broking services are a way out of the earnings compression.

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Major European Banks Back in the Game

With the shares of Deutsche Bank trading close to an all time low after a dismal 2015, the bank has quietly been revamping its prime broking business. One of the co-heads of the company’s prime broking business unit, Ashley Wilson, who was promoted in August last year, commented to the Financial Times newspaper that the bank is in expansion mode and is looking for new business.

Meanwhile another big loser in terms of share price value, Credit Suisse, has declared its prime broking unit in October to be due for “optimization”, a move that preceded a trimming at its Macro Hedge Fund Sales unit.

As recently as during the last quarterly earnings report of the company, prime broking has been re-rated to “maintain/invest”. The Swiss Bank’s chief executive Tidjane Thiam has been actively looking for ways to increase the company’s revenue stream and decrease costs, and at a time of elevated market volatility the appeal of the prime brokerage units is rising.

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A number of smaller banks are also rumored to be expanding their prime broking capabilities recognizing that hedge fund business is ripe for further growth.

Rising Volatility and Low Rates Make PB Units Lucrative

Equities, commodities and currencies have all been fairly volatile throughout the first quarter of 2016, with the volatility patterns spelling more to come in the near future. The prime broking businesses at some big banks have become much leaner in the aftermath of years of quiet markets.

With more turbulence around the corner due to ongoing uncertainty about the path of interest rates in the U.S. and the ongoing worries about the soft/hard landing scenario in China, demand from hedge funds for prime broking services is rising. Retail and institutional brokerages in the industry are also likely to benefit from the cycle and reinvigorate demand for prime broking further.

After the top three spots in prime broking have been occupied by U.S. banks Morgan Stanley, Goldman Sachs and JPMorgan, their European competitors are ripe to reenter the market and fight for market share.

Ultra-low interest rates across the globe are likely to push more money into hedge funds, and according to a report by PricewaterhouseCoopers the industry could end up expanding its assets under management to $5 trillion from the $3.2 trillion at the end of 2015.

In the meantime we can expect that retail and institutional brokers alike would benefit from the same trend in an environment where central banks are increasingly likely to maintain their policies of keeping rates low.

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