New Basis for the Hedge Fund / Prime Broker Relationship

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29 June 2011

Implementing the Right IT Infrastructure


A study by Celent and sponsored by Broadridge looks at the changes in the hedge fund / prime broker relationship and how this is fostering an evolution of the IT infrastructure of the prime broker.

In this report, New Basis for the Hedge Fund / Prime Broker Relationship, Celent analyzes the main trends changing the relationship. Then we detail how these changes should foster an evolution of the IT infrastructure of the prime brokers to facilitate providing value-added services to create a competitive dif- ferentiator. The financial crisis has changed risk behavior and risk tolerance within the capital markets industry. The bankruptcy of Lehman Brothers, leaving US$65 billion of hedge fund assets frozen, has pushed hedge funds to reconsider their relationship with the leading prime brokers. The multi-prime broker model that was slowly being adopted before 2007 has gained momentum and is now considered best practice within the industry.

Adoption of the multi-prime model has put a burden on funds, especially for data aggregation, which can be delivered by prime brokers with the right technology in place. The platform should be required to pro- duce unified reports from disparate structures and formats provided by different brokers, and deliver a uni- fied view of positions, trades, and balances.

In addition, as hedge funds increasingly implement multi-asset strategy, they expect reporting and position keeping across asset classes and often the ability to offer cross-margining as well. “The market is still dominated by single asset solutions, but the movement is clearly toward a multi-asset prime brokerage platform supporting clients’ expansion into new asset classes. Complete cross-product post-trade processing is where the industry needs to go to,” says Axel Pierron, SVP at Celent and author of the report. Multi-asset prime brokerage platforms allow the prime broker to increase its value proposition. By covering a wider spectrum of the assets traded by its customers, the prime broker will not only provide a “one stop shop” but also increase its ability to manage collateral requirements and risk exposures for its customers.

“Prime brokers’ customers are expecting them to carry real time processing and statuses, intraday busi- ness controls, and real time settlement and position status. This is obviously challenging in a multi-asset and multi-market environment.” adds Pierron. “Additional tools are needed in the risk management context to accurately compute the portfolio’s exposure and other risk measures. Therefore, the platform should not be limited to providing a consolidated view of positions and integrated reporting. “The concern about coun- terparty risk has not disappeared, but the leading prime brokers seem to be recovering market share due to superior balance sheet and level of sophistication. The drive that benefited the mini-prime providers has clearly slowed down. However, the positions are not set in stone. With fierce competition among providers in this space, there is a clear window of opportunity for financial institutions.”