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Technology, Uncle Sam challenge prime brokers: UBS

NEW YORK (Reuters) - Wall Street’s prime brokers, abandoned by their anxious hedge-fund customers last fall, face more challenges from new technology and the U.S. government’s plan to step in as a lender of last resort, UBS’s head of global prime services, Alex Ehrlich, said on Monday.

Alex Ehrlich, Managing Director, Global Head of Prime Services and member of the Board of the UBS Investment Bank, speaks at the Reuters Global Hedge Fund and Private Equity Summit March 23, 2009. REUTERS/Brendan McDermid

The long-standing domination of the prime brokerage business by Goldman Sachs GS.N, Morgan Stanley MS.N and Bear Stearns was toppled last year as worries about the credit crunch and the stability of brokers led hundreds of fund managers to move business to banks with better credit.

Looking ahead, the Big Three likely have been unseated for good, as competitors introduce the same kind of technology that Apple's AAPL.O iTunes used to supplant the record companies, Ehrlich said.

“If I were running a hedge fund, I’d be looking at all the banks and wondering what my best funding solution was,” Ehrlich said at the Reuters Private Equity and Hedge Fund Summit. “The industry has never been more ripe for Steve Jobs-like innovation.”

Ehrlich declined to elaborate on how UBS UBSN.VX would deliver new technology, but he indicated the answer involved unbundling the financing and other services a prime broker provides.

“Banks are all so focused on their balance sheets, that you think if someone comes along with a pure funding model, it could disrupt the prime brokerage model,” he said.


As much as half of all prime brokerage market share moved around to new providers last year when the collapse of Lehman Brothers in September sparked a run on other broker-dealers. UBS gained market share, though its business also has been hurt by the contraction of the hedge fund industry.

“Prime brokers learned some powerful lessons” last year, said Ehrlich, who ran Goldman’s prime brokerage before joining UBS in 2003. Among them, “the stability of funding coming from banks wasn’t as ironclad as history had taught.”

The big broker-dealers have stabilized since last fall, but they are now focused intently on using capital carefully and seeking the highest returns. Some prime brokerage activities have been cut back as a result.

And while the collapse of Long-Term Capital Management in 1998 taught firms to seek more stable sources of funds, “what people learned in 2008 was that they hadn’t gone far enough,” he said.

UBS was a net gainer of hedge fund market share, he said. “We lost nearly no business and won some business.”

That said, all the bank prime brokers may have been superseded by an even bigger competitor: the U.S. government. As part of the Treasury Department’s plan to revive banks and remove toxic assets from the system, Secretary Tim Geithner laid out plans on Monday to provide funding to large hedge funds that agree to purchase these assets.

“To a degree (the government) will be a competitor,” he said. “I’d love to step into that gap, but as public companies, not many banks could afford to take that risk,” he said.

Reporting by Joseph A. Giannone; Editing by Gary Hill