Prime Broking gears up for a new era after the collapse of Archegos


On a cloudy morning in early 2016, then Irish Taoiseach Enda Kenny opened Credit Suisse’s new trading room in Dublin and said the city had joined “a small club of shopping venues in the world. whole”.

The office would serve as the trading center for the Swiss bank’s premier global brokerage division, a firm that helps grease the wheels of hedge fund clients by lending them money and stocks to execute trades.

But nearly six years later, hopes that Dublin could become a major outpost in the bank’s global operations have faded.

Instead, the future of the office and its 90 employees has been swept away by the fallout from the collapse of Archegos Capital, an obscure family office whose demise has left its major brokers with $ 10 billion in losses and industry at large facing its greatest upheaval since the global financial crisis.

European and American banks have long used prime brokerage, an activity with stable but unspectacular returns, as a means of forging more lucrative relationships with hedge funds and, in smaller numbers, family offices.

Archegos, headed by Bill Hwang, a former member of the legendary Tiger Global hedge fund, was one of those clients. By the time he was cremated over a weekend in late March, Archegos had several of the world’s largest banks, including UBS and Morgan Stanley, as prime brokers.

Credit Suisse’s $ 5.5 billion trade loss was the worst in its 165-year history, prompting the bank to act. Last week, the lender said it would almost quit a business it had been in since 1996.

While the bank was the most publicized victim, blue chip brokerage executives and industry analysts say the consequences of Archegos could still prove far-reaching, with regulators considering tougher rules and smaller players. reassessing whether the business is still worth it.

888 Seventh Avenue, the building that housed Archegos' offices in New York
The Archegos offices in New York. The company had several of the world’s largest banks as prime brokers © Jeenah Moon / Bloomberg

“The immediate impact of Archegos has been a much greater concentration of business in the hands of the larger prime brokers,” said Youssef Intabli, research director at Coalition Greenwich, which follows trends in investment banking.

“Hedge funds have chosen banks that are reliable and good at risk management, offering a range of products and having very good execution. Smaller and more specialized players have lost, ”he added.

Japanese bank Nomura, the second hardest hit by the Archegos debacle with losses of $ 2.9 billion, has also made a pull-out offer. The lender has decided to withdraw from the cash prime brokering offering in Europe and the United States this summer, although it will continue to provide the services in Japan.

“The balances you need to make this business profitable suggest that we will only be left with seven or eight global players after Archegos shakes the market,” said an investment banker who oversees a premier brokerage firm. order.

“There will be the giants of Wall Street, plus two or three from Europe, and that will be it. No one else will be able to compete on this scale, ”they warned.

The three market leaders – JPMorgan, Morgan Stanley and Goldman Sachs – oversee as many blue-chip brokerage assets as the other nine players combined, according to Coalition data.

Bar chart of the percentage of hedge fund COOs surveyed who said theirs had weakened in the past 12 months, showing confidence in the prime brokerage relationship

The extent of the damage caused by Archegos is due to reckless use of leverage. Hwang persuaded several investment banks to grant billions of dollars in credit to the family office to increase its betting focused on US and Chinese stocks.

Its use of a type of derivative known as total return swaps ensured that neither of the major brokers knew how much the other was exposed to Archegos.

This is an area that industry executives expect regulators to focus on. The Federal Reserve and the Prudential Regulation Authority in the United Kingdom are evaluating the advisability of introducing stricter supervision.

Credit Suisse’s premier brokerage business spanned its headquarters in Zurich, its two main investment banking centers in New York and London, and Dublin, where the bank obtained the very first license to ” third country branch ”in Ireland, which has enabled it to operate there with limited local supervision.

“Anytime you have that sort of thing… All the dials go up to 10,” said a regulatory expert from an investment bank. “The degree of oversight that is needed, internal to the board administration and regulator, is going to be high. “

People walk past the offices of Nomura in Tokyo, Japan
Nomura was the second hardest hit by the Archegos debacle with losses of $ 2.9 billion © Kiyoshi Ota / Bloomberg

For banks that offer top-notch brokerage services, especially smaller ones, the decision is firm on whether the business is still attractive given the low income it generates.

“You don’t expect to make a ton of money directly, but it’s supposed to allow you to deepen the relationship with the client,” said the boss of another investment bank that has a premium division. brokering. “It’s the anchor of the relationship, but it doesn’t make sense to offer it per se. “

Credit Suisse, for example, generated just $ 16 million in revenue in 2020 through its relationship with Archegos. While it acknowledges that dropping premium Broking would hurt its equity capital markets division as hedge fund clients no longer use other services, Credit Suisse said its balance sheet could be rolled out more. profitable.

CFO David Mathers said these were sacrifices he was willing to make to focus more on wealth management, which had little overlap with the core business.

“We are making a very deliberate strategic decision to leave a company that has a very high leverage, is highly transactional in nature and has a very high degree of complexity,” he said last week. “I think it’s exactly the right thing to do.”

Credit Suisse said exiting the Broking Premium would cost it $ 600 million in revenue, but would be offset by $ 400 million in cost savings. Berenberg analysts estimate the move will lead to a 4% drop in the group’s revenue in 2023.

While the Archegos scandal has cast a shadow over Prime Broking, some banks are not discouraged and are trying to capitalize.

French lender BNP Paribas, which has long aspired to be one of the top three in an industry dominated by Wall Street, has picked clients of Credit Suisse hedge funds over the past six months, bankers from several different lenders say .

“If you have a solid premium business, you not only meet the equity needs of hedge funds, but they can also do credit, rate and currency trading with you,” said Olivier Osty, head of global markets at BNP Paribas’ investment bank. “This halo effect is really the key.”

Loss size bar graph (in billions of dollars) showing that banks have lost more than 10 billion dollars from Archegos

Credit Suisse reached an agreement this week recommending the transfer of its clients to BNP, which bought the main financing unit of Deutsche Bank two years ago. The French lender expects to capture up to half of Credit Suisse’s blue chip assets, enough, it hopes, to overtake Barclays in the rankings.

“Many Credit Suisse clients say they already have [relationships with] two US banks, and they needed some diversification. The biggest beneficiary was therefore the former Deutsche company which now belongs to BNP and, to a lesser extent, to UBS, ”said a London executive from a US bank. “The fallout really helped other Europeans. “

While the windfall for some rivals to exit Credit Suisse has been sudden, any change in the way the industry is regulated will likely be slower.

Weeks after the collapse of Archegos, Federal Reserve Chairman Jay Powell expressed concern about the scale of the losses “in a business that is generally seen as presenting relatively well understood risks.”

Seven months later, the Fed’s review of the episode continues. In the UK, the PRA said it had spoken to companies and other regulators as part of “our continuous monitoring approach” since banks disclosed the losses.

Swiss regulators initiated enforcement proceedings against Credit Suisse for breaches of risk management and ordered short-term remedies, including a capital surcharge. A spokesperson for the regulator, Finma, declined to comment on the matter.

While Japanese regulators are also assessing the changes, industry leaders predict that any new rule will force more transparency in transactions, especially when it comes to derivatives.

“It’s a very specific business with very specific risk, where you don’t know exactly the size of the risk and your client’s funding footprint,” said the director of an investment bank. “It’s practically the only banking area where you don’t know everything your customers are doing. “

Additional reporting by Sarah White, Stephen Morris, Joshua Franklin and Nicholas Megaw


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