Citi Ready for Prime Time

It bulks up its prime brokerage in a bid to grab hedge fund action.
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Citigroup

(C) - Get Report

is bulking up on prime brokerage services to grab more hedge fund clients.

The New York banking titan has created a joint venture between two of its corporate and investment banking business -- capital markets and transaction services -- to better cater to this much sought-after, highly lucrative clientele.

The news comes as Citi reportedly considers a sharp cutback in U.S. jobs in a bid to

hold down expense growth.

"By unifying our multi-broker, multi-strategy capabilities under one business, Citi is ideally positioned to anticipate and address the increasingly complex needs of hedge fund clients anywhere in the world," the company said this month in an internal memo.

Under the new unit, Hedge Fund Services, Citi will offer prime brokerage services for equity financing, fixed income and foreign exchange transactions. The initiative also includes capital raising and capital introduction -- the process in which the broker "introduces" qualified investors to funds -- consulting and administration services.

Citi's attempt at garnering a larger slice of the lucrative hedge fund sector will be much watched by the industry. The move will pit Citi against such Wall Street titans as

Goldman Sachs

(GS) - Get Report

,

Morgan Stanley

(MS) - Get Report

and

Bear Stearns

(BSC)

.

But as hedge funds go mainstream, more banks and brokers are want to service these growing funds. Big names including

Lehman

(LEH)

,

Bank of New York

(BK) - Get Report

,

State Street

(STT) - Get Report

and

Northern Trust

(NTRS) - Get Report

have been buffing up their own offerings. Even commercial banks are pushing their hedge fund services.

"Hedge funds are driving 30%-50% of revenue on certain key

trading desks," writes Guy Moszkowski, an analyst at Merrill Lynch, in a March 13 note.

"Our pipeline of incoming prime broker clients has never been larger," said Chris O'Meara, Lehman's CFO, during the company's first-quarter earnings call last week.

According to a May 2006 report conducted by Greenwich Associates and

Global Custodian

, about 20% of hedge funds worldwide planned to hire a new prime broker in the coming year. Funds that were expanding their investing into new geographies particularly were looking for additional prime brokers, the report said.

Of the 358 participants that had more than $1 billion in assets, more than half said a prime broker's reputation was the most important factor in selecting a new one. (A typical hedge fund uses two or three prime brokers.) The competitiveness of financing rates and reporting capabilities were the second and third highest priorities.

Hedge funds are also increasingly dependent on their prime brokers for business consulting services such as risk management, technology and regulatory compliance, the report said.

A key goal for Citi in two to three years is to "close the gap to industry leaders in prime brokerage," writes Merrill's Moszkowski, who had recently met with Michael Klein, Citi's head of corporate and investment banking. "Klein discussed the importance of hedge funds and private equity to continued growth for the business. By utilizing its across-the-board strength in investment banking, Citi can bundle services for clients and be a one-stop-shop for the needs of financial sponsors."

But Citi's name isn't always the first that comes to mind when hedge funds seek prime brokers. One industry observer said he didn't know of any hedge fund that uses Citi's offering.

Jeff Harte, an analyst at Sandler O'Neill & Partners, says it will be tough for Citi to gain a substantial part of the market.

"It's not something that they're viewed as big in," he says. "Hedge funds typically have multiple brokers. They're going to want their main prime brokers to be long-term players. That's going to make it a tough road for anyone to climb."

Citigroup was "late to the game in prime brokerage. They've openly admitted that," Harte says. "They've built a credible offering, but they're still a long way from having a leading market share."

Citi promoted Steve Bowman, formerly its head of fixed income sales, to lead the initiative. Bowman reports to James Forese, the head of Citi's global equities, and Neeraj Sahai, Citi's global head of securities and fund services, a subsection of transaction services. He was not available for an interview.

The company also recently opened a prime brokerage office in Singapore to capture more of the growing Asian hedge fund market.

Ron Geffner, a hedge fund lawyer at Sadis & Goldberg, says Citi already "brings a lot of firepower" to the prime brokerage business.

"It will just need to continue being aggressive in growth of this business," Geffner says. "That includes marketing and soliciting clientele and continuing to develop the capital introduction arm and various other services that they provide."