How is the dynamic between hedge funds and prime brokers changing, and why?
The dynamic has been shifting as a direct result of events such as the failures of Bear Stearns and Lehman Brothers, and the repercussions are still being felt. These events, combined with the fall-out from the credit crisis, have been lining up to change what was previously a tight club of prime brokers offering a ‘bundle’ of highly personalised services, into what amounts to a broadening range of service providers offering specific elements of service.
This is being driven in part from the perspective of the hedge funds seeking to distribute their risk, but also from a viewpoint of the leading prime brokers, who, due to other balance sheet pressures, are less keen to do business with any/all hedge funds. Other institutions, such as custodians, which may now be holding the assets of the hedge funds, are also keen to enter into the fray in order to benefit from the new revenue stream that servicing hedge fund clients can bring through financing, short positions coverage and transaction charges.
How is the regulatory focus on prime brokers affecting their relationships with hedge funds?
Regulatory pressures are leading to more focus on how the capital of the firm is deployed across the business, in addition to greater focus on the counterparties with whom business is being done. The demand for asset segregation, and restrictions around the prime broker’s access to hedge funds’ assets to finance its own business, has clearly been a significant change. On the other hand, the regulation of hedge funds, under structures such as UCITS, has led to an increase in the growth of the number of funds, and the attraction of more institutional money into them. Overall, AUM by hedge funds is north of $2 trillion and is heading to an all-time high, and although there were a number of closures in the earlier part of the crisis, the growth in new hedge funds is now strong. These factors mean that hedge funds, and the provision of services to them, is a relative bright spot in comparison to many of the shrinking volumes and values that we see in other areas.
How important is it that hedge funds diversify their risks and increase transparency?
In common with other sectors in financial markets, the failure of leading prime brokers brought home to hedge funds the fact that risk was not all on the side of the prime broker, but that the larger financial institutions, such as investment banks, could also fail. This led to the spreading of risk across multiple prime brokers, and a demand for greater, and more frequent, visibility of the business being handled by the prime broker. In particular, the citing, and usage, of the hedge fund’s own assets is receiving much attention. The requirement to have access to more detailed, and more frequent information, potentially in real time, has led to demands for improvements in the less interesting, but clearly critically important aspects of the daily interaction between hedge funds and their prime service providers.
What are prime brokers doing in response to this?
Prime brokers responded through the creation of bankruptcy-remote entities to house collateral, or in some cases partnerships were created between prime brokers and third-party party custodians in order to demonstrate the clear segregation of assets. The focus on client service providing visibility of the operational controls and reporting that are associated with the daily processing, and in particular asset utilisation as part of financing, became even stronger. There are certainly more conversations around the rather less exciting post-trade processing services than ever before, as hedge funds demand access to more in-depth and frequent information.
Where does the Apex Prime solution fit in?
Apex Prime was designed specifically to help the client services representatives manage the day-to-day operational activities and reporting demands in a more efficient way. It provides a one-stop-shop for all of the information that the service representatives need, ensuring that they can respond in an effective and timely way to hedge fund client demands.
Apex Prime is targeted to help new players that are keen to attract hedge funds flow and revenues, to get up and running with minimal cost and lead time. Historically, existing primes have employed huge IT resources in order to develop solutions to fulfill these requirements, and getting into the prime services business was only for those with very deep pockets for IT spend. Apex Prime aims to level the playing field by providing new players with an innovative solution to address the key, and specific, prime service functions. It can also help existing primes streamline processes and reduce costs in this area.
It also integrates closely with our securities finance solutions, but also with many other SunGard systems that are typically used by prime brokers, such as SunGard’s trading, execution, back office, risk management, and regulatory compliance solutions. This has the advantage of reducing time and cost-spend on the implementation of the solution, which will clearly sit at the epicentre of a spider’s web of other solutions at a prime service provider.
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