It’s been just over five years since Wells Fargo snapped up Merlin Securities and made its entry into the prime brokerage business.

Given the backdrop of increased regulations post-financial crisis, the firm envisioned a scenario where hedge funds would be looking for additional liquidity providers.

At that point, many of the existing, well-established prime brokerage houses were aligning their business models to account for the new regulations.

The Merlin move allowed the bank to get its foot in the door and begin to build a self-clearing prime brokerage product under the banner of Wells Fargo Prime Services.

Moreover, the acquisition meant Wells could leverage existing institutional client relationships across its capital markets and banking franchises. 

According to Rob Sackett, head of securities lending at Wells Fargo Prime Services, the combination of the bank’s financial capital position coupled with sustained investment in the prime brokerage business has been a compelling story to clients.

“We offer more than just balance sheet and credit and differentiate ourselves by offering depth and breadth of expertise across securities lending, capital introductions,  business consulting and client services,” New York-based Sackett told Global Investor.

Sackett has over two decades of experience across prime broking and equity finance and arrived at Wells in the summer of 2015 to lead securities lending as well as support the prime brokerage and equity trading businesses.

His securities lending team currently comprises 14 executives specializing in hard-to-borrows, general collateral, ETFs, international and sales trading.

“From a pricing perspective, we feel that it is our job to minimize clients’ expense on the short side by leveraging automation, liquidity, market intelligence and overall book management,” Sackett added.

“We also have been developing a fully-paid business.  We add further value by minimizing long side expense by the transparency we offer to clients as to the value of their long holdings.”

Wells Fargo currently clears 24 countries, the largest being its home market the US, followed by Canada, Western Europe, and Asia.

In addition to equities, the bank clears ETFs, convertible and corporate bonds both investment grade and high yield, closed-end funds and special purpose acquisition companies.

Capital introduction and consulting are also significant components of the firm’s offering.

As well as assisting smaller/emerging managers raise capital, expertise extends to mid and large size hedge funds, connecting managers with pensions, endowments, sovereign wealth funds.

In terms of consulting, the core areas of focus include hedge fund formation and structure, strategic start-up advisory, product solutions and technology best practices, operational due diligence and peer group analysis.

“We service equity long/short, credit, convert, quant/market neutral and multi-strat funds in addition to other strategies as part of our core offering,” Sackett explained.

“While the cap intro and business consulting teams are a tremendous asset to the start-ups, they are also important to mid-size to large funds as well. As hedge fund assets have grown for many of the larger hedge funds, our balance sheet and credit offer further opportunities for diversification.”

Since Sackett’s arrival, the firm has continued to build out its platform and extended its margin capabilities to address various leverage ratios that client need to deploy.

“Our initial offering was a Portfolio Margin (PM) offering which provided leverage ratios up to 6.7x. Last year we rolled out our Regulation U offering from our bank platform – Wells Fargo Bank, NA.  This platform allows us to offer competitive margin levels when compared to our peers for strategies (quant/equity market neutral), that require leverage greater then could be achieved in a US broker-dealer construct.”

In addition, the firm is working on building out a short-arranging platform that employs two US broker-dealers – this is set to launch in the second quarter of 2019.

Meanwhile synthetic/Delta 1 capabilities are growing and, according to Sackett, the group has a “market leading platform” particularly around master limited partnerships, real estate investment trusts and custom basket product offerings.

His team is also looking at agents and third party lenders for further liquidity. 

“We have partnered with our agent lenders to access additional pools of liquidity, term borrow and non-cash facilitation,” he explained.

“Other areas of liquidity open to us include bidding on exclusive portfolios of assets from beneficial owners.”

CCPs

As prime brokers manage business metrics such as ROA, ROE, RWA’s, collateral netting, and their capital requirements, Well Fargo not only looks to the non-cash market but trades through CCPs. 

While these venues are not open to all market participants, Sackett is bullish on its positive capital effects through decreased RWA’s and credit exposure and feel that over time, more participants will trade with these venues. 

“While there is a balancing act between managing relationships between CCP and non-CCP counterparts, we feel there will be growth in all participants in the future.”

Along with the emergence of the CCPs in the securities lending workflows, we have seen an increased appetite from internal and external participants on getting additional transparency through enhanced data analytics. 

“The securities lending data vendors continue to enhance their product offerings by including more participants and enhanced market coverage,” he added. “Each of these vendors have carved out areas of specialty; whether its market coverage such as US versus international or real-time versus an overnight batch. 

“The constant trait among all these vendors is the fact that they are getting increased buy-in from both the buy and sell-side communities which is allowing their product offerings to be adopted into the end-users workflows.”

Sackett is also seeing continued growth in vendors organizing data between primes and hedge funds in order to optimize trade flows to manage short rebates, long lending opportunities, and balance sheet in order to enhance client financial metrics such as ROA, ROC, ROE, and RWAs.

In terms of the industry’s challenges, Sackett says the biggest threat to the prime brokerage model post-regulatory reform has been the underperformance of the industry as a whole when compared to the relative benchmarks.

“This underperformance coupled with reduced management & performance fees and higher costs due to increased regulations have led to a sustained period of higher fund closures than launches.

“Over the past year some of the negative publicity around the hedge fund industry has subsided given good performance in 2017, increased institutional demand for yield in a low rate environment which has pushed AUM to all-time highs of $3.5 trillion, increased market volatility, strong deal calendar and a pro-business rhetoric, are all viewed as factors potentially helping the industry.”  

Looking ahead, Sackett is staying optimistic and closely monitoring the growth of fintech.

“Whether it’s potential process efficiencies gained via applying block chain technology, enhanced data analysis and subsequent decision making through AI or machine learning are all being viewed as technologies that will add tremendous value to the prime brokerage industry.  The value will be on both sides of the income statement. 

“We should see better sec lending trading, client pricing, and collateral optimization decisions which should result in pricing efficiencies as there will be less reliance on infrastructure, front and back office personnel, processing times and volume, and trade reconciliations,” Sackett concluded.

Disclaimer:

Wells Fargo Securities is the trade name for the capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including but not limited to Wells Fargo Securities, LLC, a member of NYSE, FINRA, NFA and SIPC, Wells Fargo Prime Services, LLC, a member of FINRA, NFA and SIPC, and Wells Fargo Bank, N.A. Wells Fargo Securities, LLC, and Wells Fargo Prime Services, LLC are distinct entities from affiliated banks and thrifts.