RBS hangs hat on prime brokerage to boost FX revenues

At the turn of the new millennium, when FX prime brokers came up with ways of automating and creating a scalable business, the daily turnover of the FX market was around $1.4 trillion. Since then, volumes have tripled. The commonly held view is that aside from the mass adoption of electronic trading, FXPB was the next biggest contributor to the rapid growth of the FX market. When considering the stellar return on equity on offer, FXPB has become a must-have for any serious FX franchise. For Royal Bank of Scotland, it could be called the anchor. RBS, facing growing competition, is staking its claim as the tried and trusted prime broker that has built a loyal client base, and is continuing to grow that base. In talking with many of those clients, that assertion seems to have some basis.

"In a lot of banks, prime brokerage evolved in other asset classes and FX was an add-on," says Ramasamy Venkatesh, RBS’s global head of FICC prime brokerage. "At RBS, it was the other way around: FX came first and rates came later."

FXPB first appeared in the mid 1990s when Bankers Trust, ABN Amro and AIG started offering the service. When Deutsche Bank acquired BT in 1998, it set about creating a more automated and scalable solution. Around the same time, RBS began to do the same, with much of its focus then on the growth area of high-frequency trading. In recent years, it has been diversifying that client base by acquiring hedge fund clients.

Essentially, the prime brokerage service is broken into three key areas: market access; risk management; and infrastructure and operational capacity. The blend of these three will depend on the type of client. RBS says it offers six or seven different models on its platform, and therefore has a PB solution for all types.

That could easily be a statement from any leading participant in the FXPB market, but the RBS team cites its below average client attrition rate – less than 5% – as proof of a genuine track record and how it has successfully navigated difficult market conditions, while proving to be an effective administrator in processing more than an average quarter of a million trades a day.

"RBS PB has been a phenomenal success story for the past four years," says Venkatesh. "We have grown more than peers in the market. Our clients have stayed with us because we treat them as partner, and we have one of the lowest attrition rates in the industry."

Comparing attrition rates is a hard thing to prove, short of surveying the entire market, but Venkatesh says the bank has added new clients this year – having signed up or is in the final stages of discussions with a dozen clients. This comes as the market faces even greater competition, where new entrants in FXPB, such as Morgan Stanley, have driven fees in some customer segments, to historical lows. However, while brokerage fees are being squeezed, it is ultimately just the conduit to the overall franchise. For example, with hedge fund customers, the resulting flow business with the trading desk is considered an important component of the overall revenue generation from FXPB.

"We do run our PB business, or our client pipeline, from a desire to do volume – that’s the key thing," says Tim Carrington, RBS’s global head of FX. "We do PB for client services’ sake. I’m a sponsor of it because we’ve done it very well. I should therefore be able to see more business."

While, RBS’s reported numbers suggest FX revenues are flat for the year, after non-specific FX items are stripped out, the division’s performance in 2011 is impressive. According to Carrington, RBS revenues in the third-quarter were up 77.7% versus the same period a year ago, while year-to-date, revenues are up 19.4% on 2010. RBS will be hoping that will be reflected in market share as well.

In 2009, RBS was on the cusp of breaking into the top three FX banks. Since then, its ranking in the Euromoney FX volume survey has slipped three places, to seventh, and it has given away two percentage points in market share.

Nonetheless, the bank’s assertions of its quality of service seem to stack up, when Euromoney speaks to some existing and new clients. One thing that resonates with clients is its no-nonsense, no-frills attention to detail.

There is a personality to the business that clients seem to respond to. "They don’t have the airs and graces that a typical investment bank might have," says the head of execution at a London-based hedge fund who uses RBS as a prime broker.

"With some banks, you often get some very slick person to come in and do his half hour of rubbish, about how he’s the best person in the world. RBS has a modest approach to it. No image."

And RBS is reportedly prepared to go the extra mile. The client says his firm uses RBS’s Singapore desk to roll out spot trades, and that RBS had Bloomberg terminals installed there specifically for it because that was its preferred method of dealing. "Other banks would have insisted on using their own messaging format," he says.

Another large London hedge fund, which this year chose RBS as one of its two prime brokers, provides Euromoney with a long list of criteria it uses when choosing an FXPB.

At the top of its list is the risk profile of the PB’s organization, and if there is adequate capital and funding access, offering a range of give-up brokers and net-open-position limits. The hedge fund also stresses the importance of easy-to-use electronic systems, and accurate and transparent margin calculations and valuations.

In almost all cases, RBS met and exceeded expectations on these points, the hedge fund says.

The importance of margin calculations and valuations cannot be overstated. As volatility remains heightened and margin susceptible to sudden increases, PB clients are placing much more importance on the accurate value assessment of their cross-asset holdings. The same fund trades the full spectrum of FX products, which includes exotics and precious metals.

"It’s important that these can be supported and valued," the hedge fund manager says.

Indeed, Carrington cites the on-boarding of new clients across all asset classes as a critical step, especially when it comes to valuations. It is "a phenomenally intensive process" that can be undermined by relatively simple problems, he says. If the bank cannot value one illiquid instrument, for example, "that is a small thing to the FX business, but a huge thing to the prime brokerage client".

While RBS likes to highlight the new client acquisitions, this needs to be put in context. One industry vendor in the FXPB market says some of this recent client movement is attributable to its growing preference for multiple prime brokers to diversify counterparty risk.

The vendor says prime brokers, such as Rabobank, have been added to the list of PBs by buy-side firms, often as a standby, leaving most of the trade flow with the primary PB. In fact, some buy-side firms are adding a third PB as well as a standby.

Rabo is the only global bank that holds a triple-A rating from both Standard & Poor’s and Moody’s Investors Service.

RBS concedes that there has been a drive to have at least two prime brokers, and that it now has only a small number of clients where it is the sole PB, because of the client strategy dictates that sole PB is no longer optimal.

Being a second PB, or a standby PB, is not without risks, especially if called upon in times of crisis, argues Venkatesh. "Being a back-up PB is something we don’t encourage," he says. "As long as we are convinced that we are an equal partner with the client and see a significant part of their business on our PB platform, we don’t worry about whether we are their second PB."

Another RBS client is candid about this trend: "I don’t like the fact I have to take some of my business elsewhere, but should Her Majesty’s government one day decide it doesn’t want to provide leverage to hedge funds, then I have to be covered for that."

As Basle III, and Dodd-Frank and Mifid regulations take effect, the big difference between those that succeed and those that don’t will be who can transition their clients to a new model with the minimum of fuss. That new world is likely to lead to a bifurcated market between cleared and non-cleared portfolios, predicts Fred Matt, RBS’s global head of prime services sales. It is vital prime brokers are ready for the changes, despite the fact the rules have not yet been finalized, he says.

"If you’re a hedge fund, notions of independent amount and deposit margin, collateral and eligible universe of securities, that’s lingua franca," he explains. "If you’re a regional bank or an asset manager, it’s not just a new paradigm, it’s a new world. So those clients are going to need more thought leadership from us, in terms of how you manage that."

RBS believes that will make it even more important for a prime broker to have a holistic approach. The bank wants to be more than just another full-service, supermarket bank, offering prime and margins services – it is about looking at the bank’s relationship with the client as a whole, says Carrington.

"We will sit down with our clients at a senior level and we will look at that client across client services, across rates, FX, holistically, and we will make decisions about the client about what we’re missing, what we can add," he explains.

The idea is clear – prime brokerage is the window of the bank to the client.

Ultimately, RBS wants to be a clearing partner of the client, says Venkatesh. "We want clients to say RBS is my clearing partner, whether that is bilateral, CCP or exchange. We want to have an integrated risk management across this clearing, multiple CCPs, multiple exchanges and the bilateral business."

That will be the goal of its main competitors too, but RBS, with its down-to-earth approach and track record, hopes it can drive its market position and revenues in a new market structure amid ever more challenging markets.

As the head of execution at the London hedge fund sums up: "As the crisis has deepened, RBS has got better and better."