Universal banks winning battle for hedge business

By Laurence Fletcher and Olesya Dmitracova

LONDON (Reuters) - Broker-dealers such as Morgan Stanley and Goldman Sachs are losing out in the battle for hedge funds' dwindling pool of assets, as funds seek out banks with diverse sources of funding in a major shake-up of prime broking.

The collapse of investment bank Lehman Brothers (LEHMQ.PK: Quote, Profile, Research) in September shocked hedge funds, as those with accounts at Lehman when it sought bankruptcy protection had those assets frozen and risked being unable to close trades.

"The Lehman bankruptcy ... led many hedge funds to flee the two largest prime brokers, Morgan Stanley and Goldman, for the perceived safety of the universal banks," said BersteinResearch analyst Brad Hintz in a note.

Prime brokers make money by charging hedge funds fees for providing financing for trading and settlement of trades.

Credit Suisse (CSGN.VX: Quote, Profile, Research), whose operations include a large wealth management unit as well as prime broking, saw balances in its prime brokerage unit grow 50-60 percent last year compared with 2007, a source familiar with the business said.

Roy Martins, the bank's head of international prime services, said: "There was a peak in terms of business in September and October. All the clients we took on had existing relationships and dialogues with us as they were clients we had been targeting anyway."

Deutsche Bank (DBKGn.DE: Quote, Profile, Research), backed up by its big retail bank, has also benefited from an influx of business in its prime brokerage in the last six months, a source close to the bank said.

But Morgan Stanley (MS.N: Quote, Profile, Research) revealed in December that its prime brokerage unit, long a profit engine, saw client balances fall 65 percent in the year to November, although it said it was seeing some hedge funds wanting to move back.