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B ANK OF AMERICA (BofA) tripped up in 2008

 when it sold its primebrokerage business to BNPParibas, a transaction that couldnot have been timed worse. Thedeal closed in October, justafter the Lehman Brothersbankruptcy lit the touch paperon a wholesale redistribution of market share among primebrokers. BofA could only watchfrom the sidelines as hedgefunds abandoned long-timemarket leaders, Morgan Stanley and Goldman Sachs, in a madscramble to diversify theirsources of financing. By the timeBofA’s shotgun marriage withMerrill Lynch was consummatedin January 2009, leading primebrokers—especially CreditSuisse, Deutsche Bank and JPMorgan—had signed up scoresof new clients.

BofA then went on to inheritMerrill Lynch’s prime brokerbook, which had also sufferedclient defections as the brokerage giant stumbled at the heightof the financial crisis. Luck comes in many guises; and so ithas proved as Merrill Lynch’s prime broking business hasprovided the combined entity with a solid foundation upon

 which to rebuild market share. Today, the business has bouncedback under the Bank of America Merrill Lynch (BofAML)banner and picked up enough market share to be a majorleague contender, alongside the five other big prime brokers.

Based in BofAML’s airy and eco-friendly new offices in mid-town Manhattan, Sylvan Chackman, managing director and co-head of global markets financing and futures, runs a BofAMLdivision that has employees scattered far and wide, from London

to Beijing and Sao Paolo toSydney. The secret of its phoenix-like success lies in an integratedapproach that offers clients one-stop shopping for all theirfinancing needs. “After themerger, we combined all thefinancing businesses—repo,futures, prime brokerage inequity, fixed income and foreignexchange, swaps, securitieslending and clearing of OTCderivatives,”says Chackman. “Wehave one touch point in termsof sales and client service, and

 we look at risk globally acrossmultiple asset classes.”

 At many prime brokers, these various functions are separatelines of business with their ownincome statements, which canfoster in fighting rather thanco-operation for the firms’overall benefit. With that inmind, BofAML lumps themtogether for internal financialreporting purposes—andcompensation calculations.

“Our competitors are not getting the economies of scale,the ability to price and win new business the way we can,”claims Chackman. “We avoid internal turf battles.”

Hedge funds make up the bulk of BofAML’s clients, of course, but it also services long-only institutions that needfinancing for their futures and foreign exchange investments.The sales effort targets entities based on their overallrelationship—actual or potential—with the entire bank. Forexample, while Chackman may accept a hedge fund withless than $50m in assets if it is affiliated with an existing client from whom the bank derives other revenues, theminimum size will be higher for a standalone relationship.

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In a market that remains ultra-sensitive to counterparty credit risk and the safety of client assets, allbut two of the leading prime brokers are now owned by major universal banking groups. They

include Barclays Capital (which acquired the American equity finance franchise of Lehman Brothers),JP Morgan (which bought Bear Stearns in the spring of 2008) and Merrill Lynch, which has recovered

strongly since its acquisition by Bank of America. Sylvan Chackman, co-head of global marketsfinancing & futures at BofA Merrill Lynch (BofAML), explains how the bank has established a global,

one-touch shop for its prime brokerage services that is now itching to flex its muscles whenever hedgefunds regain their taste for leverage; and how the bank intends to give top rated prime brokerage

operations such as Deutsche Bank and Credit Suisse a run for their money. Neil O’Hara reports.

THE NEW WATCH

 Photograph © Paul Fleet / Dreamstime.com,

supplied September 2010

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Steve Keller, managing director and head of Americasfinancing sales, points out that the merger allowed BofAMLto tap the vast Merrill Lynch equity franchise for clientprospects. It helped that the taint that may have attached tothe Merrill Lynch name in 2008 has since evaporated. Indeed,the fact that the prime broker is part of a commercial bankis a huge advantage in snagging new business. “Every singlehedge fund we see is thrilled to market BofAML ascounterparty to an investor base that is increasingly interestedin business risk,”holds Keller. “Many entities that left usduring the financial crisis have come back.”

BofAML may have missed out on the easy pickings in late2008 but it has taken full advantage of a secondary shake-outamong prime brokers over the past 18 months. Moreover,since 2008 a number of major prime brokers have also showna willingness to shed some of the smaller funds; thoughthese were not the only trends in play. The relationshipbetween prime brokers and hedge funds has changedirrevocably as pressure on hedge fund managers to diversify their counterparty credit risk exposure by appointing morethan one prime broker continues, for instance.

 Any which way, BofAML has not been slow to spot andleverage opportunity. Chackman says small hedge fundsthat used to have only one prime broker now have two orthree, while the biggest funds that may once have had eightor more have cut back to four or five as assets undermanagement tumbled and trading volumes declined. “Wehave benefited from both sides,”he says. “We have seenhedge funds who only had one add us as a second or third,and we have seen big hedge funds cut two or three otherprime brokers and add us.”

 Year to date, BofAML’s client roster has expanded by anestimated 300 hedge funds run by 100 different managers,some of which were new customers to the bank as well as tothe equity division. Financing balances have jumped, andalthough low interest rates have squeezed profit margins,BofAML’s prime broker revenue is almost flat at a time whenits major competitors have reported sharp declines. In 2009,for example, Goldman Sachs’ securities services revenue(which includes prime brokerage) slumped 41%, while

Morgan Stanley’s prime broker revenue fell 20%. Chackmansees BofAML’s revenue poised to surge when hedge funds’appetite for leverage returns.

The gains won’t come only from its existing client base,either. Even though Morgan Stanley and Goldman Sachsare now bank holding companies, they don’t have the balancesheet power that established commercial banks can bring to bear. “The monoline broker model is outdated,” saysChackman. “They are holding on pretty well in a low leverageenvironment, but when that turns they could have troubledeploying balance sheet at a competitive price.”

He expects those banks that signed up so many new clientsin 2008—such as Credit Suisse, Deutsche Bank and JP Morgan—might in future struggle to retain them all, too. Wishful thinking?No, says Chackman. It’s about underlying business dynamics;and the global BofAML footprint appeals to hedge funds that

 want to borrow stock in Japan, do a swap in Brazil and repo inNew York under a cross-margin arrangement that minimisesthe collateral they have to put up, holds Chackman. “Hedgefunds want simplicity today,”he says. “They want to execute,clear and finance with one firm.”

Global reach

The demand for global reach could put even JP Morgan at adisadvantage. The old Bear Stearns prime broker business itacquired was a domestic US franchise, a focus it retains underthe JP Morgan umbrella. That leaves Credit Suisse and Deutscheas BofAML’s primary competitors on the international stage,a contest in which Chackman and Keller reckon BofAML isgaining an upper hand. “We have a world-class prime brokerthat we can scale globally,”says Keller. “Merrill had not only a leading position in the US but also a strong presence in thePacific Rim and the former Smith New Court business inLondon.”BofAML offers execution and financing in morethan 60 countries around the world, they boast.

“In today’s marketplace, our global distribution and reach,combined with research and equity, state of the artinfrastructure, pricing and margining, make us an interesting counterparty for a hedge fund,”says Mike Stewart, co-headof Global Equities at BofAML.

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 Mike Stewart,

co-head of Global

Equities at Bank of 

 America Merrill

Lynch. Photograph

kindly supplied by

Bank of America

 Merrill Lynch,

September 2010.

Steve Keller,

managing director 

and head of Americas

 financing sales at 

Bank of America

 Merrill Lynch.

 Photograph kindly

supplied by

Bank of America

 Merrill Lynch,

September 2010.

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For all the emphasis on creative financing solutions forclients, Chackman admits that prime brokers make relatively little money from margin loans and other long positionfinancing. Stock lending has always been the critical driver inprime brokerage, accounting for more than half the revenue

at most firms. From the borrowers’ perspective, the key is not just the ability to find hard-to-borrow stocks, but securitiesthat will not be called away. That’s where BofAML’s unmatchedretail presence comes into play: an enormous pool of stableassets only its clients can tap. “Every prime broker has accessto the other big custodian banks,”says Chackman. “We haveaccess to $2trn in total client assets handled by our nearly 20,000 financial advisers. It is a huge differentiator.”

Even though stock loan demand is depressed at themoment—the specials to general collateral ratio today is about3%, a far cry from the normal 15%—BofAML’s retail assetsserved its clients well last year when demand for stocks suchas Citi and General Motors soared. Prime brokers who sourcefrom the custodian banks have to play the game by their rules.For every dollar of general collateral taken, they will get anallocation of specials, typically 10% to 15%. The retail boxgives BofAML a proprietary pool that is cheaper and does notrequire a quid pro quo, an edge that the bank thinks will pay dividends when stock loan balances bounce back.

Retail assets also play a part in capital introduction, anarea in which BofAML excels: hedge funds gave the firm toprank in two recent surveys. It’s a critical function for hedgefund managers. If BofAML can add 20 basis points (20bps)to a fund’s annual return through its processing and financing services, the manager earns 4 bps in its 20% incentive fee. Onevery new dollar invested, however, the manager makes a2% management fee—50 times as much.

Low-risk business

It’s a low-risk business for BofAML too; better to be on thesame side providing services to the people who run hedgefunds than committing capital to take the other side of theirtrades. With six participants vying for leadership, the securitiesfinancing business is more competitive than ever. Hedgefunds have cut their leverage dramatically, and while many delivered robust performance in 2009 gains have been elusivein this year’s choppy markets. “If you are a hedge fund chief finance officer or chief operating officer, how do you helpmaximise returns?”asks Chackman. “In the last six months,

 we have seen more negotiations around pricing and terms.”The smart funds don’t push for every last nickel and dime,

however. They know that at some point they will need moreleverage and resources—and prime brokers will be moreaccommodating to funds that didn’t press too hard whentimes were tough. “You don’t want to be transactional aboutthis business,”says Chackman. “The bigger funds understandthat. They want strategic partnerships.”

Those relationships have helped BofAML ride the crest of the UCITS wave in Europe, where even before the mergerMerrill Lynch had staked a claim to market leadership. TheUCITS framework permits money managers to sell fundsregistered in a single country throughout the European Union

 without having to meet onerous requirements for a localoffering in each jurisdiction. Keller says BofAML has already launched UCITS vehicles for six big hedge funds and expectsto sign up another dozen or so clients before year end—withmore to follow in 2011. “The UCITS franchise we have inEurope is unmatched,”he says. The big hedge funds are likely to get bigger over the next couple of years, too. The new USregulations that require broker-dealers to scale back theirproprietary trading—the “Volcker rule”—will be good forhedge funds because it will free up investment bank capital andresources to service clients rather than in-house proprietary trading desks. Traders are likely to jump ship as well, eitherto join existing hedge funds or to start their own operations.

Meanwhile, the barriers to entry keep going up, as does theminimum economic size for an existing fund. “I see a massiveconsolidation among hedge funds,”says Chackman. “Many funds that are below their high-water mark may be forced tofold.”He believes the 7,000 hedge funds that exist today couldshrink to 4,500 or 5,000 in two years’time—but does not expectassets under management to shrink. He explains: “The tail isso long, 14% of the hedge funds control 85% of the assets.It’s the small funds that are at greatest risk.”

In fact, some large funds have taken in so much money that they are already closed to new investors. “Many hedgefunds are having a very difficult time raising money, but thebiggest are now so successful they are closing,” says Keller.The trend will play to BofAML’s strength among hedge funds

 with assets in excess of $10bn, another survey category in which it topped the bill.I

Sylvan Chackman, co-head of global markets financing & futures at 

Bank of America Merrill Lynch. “After the merger, we combined all the

 financing businesses—repo, futures, prime brokerage in equity, fixed

income and foreign exchange, swaps, securities lending and clearing of 

OTC derivatives,” says Chackman. Photograph kindly supplied by Bank

of America Merrill Lynch, September 2010.