Well, that wasn’t very festive. News that Citigroup is facing a big loss linked to a currency trade by a hedge-fund client in Hong Kong is not just bad news for the year-end bonuses of the employees concerned (one of whom has already lost his job). It also casts doubt on the credibility of top management at the giant US bank. They have had to admit that key profit targets may be missed as a result.
Still, Citi’s appetite for prime broking — supplying hedge funds with everything from loans,to research and introductions to investors — is likely to be undiminished. This line of business has been one of the most dependable on Wall Street over the past decade. Other lines such as trading have struggled. Cheap electronic platforms have taken their toll on profits.
Within equities divisions at the top dozen global investment banks, the contribution from prime broking has risen from about 30 per cent of total revenues five years ago to 40 per cent now, according to Coalition. Much of that growth has been driven by excitingly-named “Delta One” desks, which put together trades based on derivatives such as swaps. In mid-October, Citi’s finance chief singled out its prime and Delta One businesses as the main reasons why total equities revenues held up during the third quarter. This offset weak cash-trading volumes and lower commissions.
Blow-ups can trigger messy litigation. A legal battle between the partners of a hedge fund in Oklahoma, for example, has ensnared Jefferies, which is accused of allowing one partner to run illicit trades on the side. And competition for staff can be intense; Bank of America suffered a string of departures from its prime broking unit earlier this year.
But returns on assets are very high — perhaps 200 basis points on loans, and 250bp on synthetic trades. Citi, for its part, has responded to the setback by redrawing its organisational chart, putting its foreign exchange prime-broking unit under closer supervision. The occasional bust-up is a risk worth taking.
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