[HONG KONG] Morgan Stanley won more than 90 prime- broking mandates from hedge funds in Asia last year when rivals slowed expansion under tighter bank capital and liquidity rules.

The mandates were about evenly split between startups and established funds, said Nick Footitt, a Hong Kong-based spokesman for the world's second-largest provider of services to hedge funds, declining to give the number of regional clients.

The bank is prepared to provide services to smaller hedge funds, even when the return may be low for the first one or two years, said Mehdee Reza, the Hong Kong-based head of core prime brokerage for Asia.

"Funds of all sizes have value to us," said Lorraine Wong, Morgan Stanley's head of Greater China prime brokerage. "While larger clients are clearly critical to our franchise, we are also focused on identifying the next generation of up-and- coming funds."

The Basel III capital and liquidity rules introduced to prevent a repeat of the 2008 global financial crisis have raised the funding costs of prime brokers and reduced the amount available within banks' balance sheets for hedge-fund clients, according to a JPMorgan & Chase Co. report last year. Some have shied away from new hedge funds, trimmed relationships with less lucrative ones or raised fees for clients who don't meet profitability targets.

Prime brokers provide services such as lending securities and cash to hedge funds, and settling trades. They can gain mandates from startups, new funds added by existing clients or when hedge funds switch prime brokers.

Bank of America Corp cut ties with about 150 hedge funds last year, people familiar with the bank's strategy told Bloomberg in January. Goldman Sachs Group Inc pushed some customers to move cash from the bank and cut back on some forms of client lending.

"We had a good year last year, even better than 2013, with a significant number of our new mandates coming from existing clients," said Mr Reza.

Morgan Stanley was the largest prime broker in Asia by the number of mandates after Goldman Sachs, according to a 2014 survey by trade journal AsiaHedge, published by London-based Hedge Fund Intelligence. It was the biggest after Goldman Sachs and Credit Suisse Group AG by the estimated share of regional hedge-fund assets, based on information shared by banks and their clients.

Global Basel III rules are forcing prime brokers to increase their focus on clients whose size and investment styles can translate into higher returns for banks while tying up less of their balance sheets, according to reports including the JPMorgan note.

They are also doing so as investors have directed the bulk of new inflows to the hedge-fund industry after 2008 to managers with at least US$5 billion of assets, making it harder for smaller funds to expand.

The outlook for hedge funds, already shutting at the fastest pace since the crisis, is about to worsen as smaller funds struggle to generate enough performance fees to cover operating costs. Profit in the industry dropped 30 per cent on average last year because of poor returns, according to a January report by Citigroup Inc.

In Asia, Morgan Stanley has taken on some clients who manage less than US$10 million of assets, Mr Reza said. Smaller and younger hedge funds tend to hire fewer prime brokers, potentially giving the banks they choose more business.

After the 2008 crisis, hedge funds increased the use of multiple prime brokers to reduce the risk of being caught in a bank collapse. Morgan Stanley was appointed sole prime broker to the funds in almost half of the new mandates last year, said Mr Wong, who is based in Hong Kong.

The average Asian hedge-fund startup raised US$19 million last year, according to Eurekahedge Pte. It typically takes almost two years for a hedge fund in the region to boost assets to US$250 million from US$50 million, if they ever reach that threshold, according to the Singapore-based data provider.

"The hedge fund industry can be very cyclical," said Mr Reza. "What we have found is if you are early with a hedge fund you can develop enormous mutual loyalty over time."

Morgan Stanley was the second-largest prime broker in 2013 with more than 1,300 clients globally, giving it a 16 per cent market share, trailing only Goldman Sachs, according to a November 2014 Yale School of Management paper that cited filings to the US Securities and Exchange Commission.

BLOOMBERG