Since the financial crisis, Fund Managers have increasingly moved away from using a single custodian and diversified their risk by splitting the basket under multiple Prime Brokers (PBs). This has provided them with an opportunity to utilize different partners for the different services that they offered, diversifying their asset portfolio mix and market reach.
Fund Managers have now largely switched to this multi-prime business model due to the flexibility it provides and the associated reduction in counterparty exposure it offers. As their investment managers continue to expand into strategies that promise high returns, they look for opportunities that provide access to new securities, geographies, mitigation of risk and competitive pricing.
This model provides the benefits of diversification, access to a wider product range and competitive pricing to Fund Managers. Meanwhile it brings with it a new set of operational challenges for the PBs. These challenges include administration, counterparty risk and monitoring, trade allocation, reconciliation, risk management, portfolio accounting, integration of new fund managers, and reporting.
While the industry’s migration from a single-prime to multi-prime model has benefited Fund Managers, it has also increased complexity in their operations. At the same time, PBs are faced with a much more demanding clientele that can use its diversified base for extracting better financial terms and operational considerations.
An Independent Multi-Prime Utility
In the future, Prime Brokers and Fund Managers will need to create an environment in which they can regain focus on their core competencies. For the fund Managers this means concentrating on generating alpha for their clients, without being burdened by aggregating positions and performing other middle- and back-office functions. On the other hand the PBs will be able to focus on providing value-add services, such as Securities Lending, Margin Financing, Synthetic Lending, Repo Financing, Swaps, etc.
A key element of this environment is a utility that would provide a seamless platform upon which to conduct various business transactions and related operations. It would mitigate the complexity of handling different systems, formats and associated protocols and enable the consolidation of back-office functions that neither PBs nor Fund Managers are well-positioned to perform. An independent utility—hosted either by a collaboration of PBs and Fund Managers, or by a third party—can act as an interface between the PBs and Fund Managers.
This utility will be built upon an independently hosted infrastructure maintained by a third party. It will integrate with multiple PBs and provide a single interface to Fund Managers, enabling simple access to many PBs offering different services and market access. To access a new PB, the Hedge Fund will only need to subscribe to that PB, without having to go through the long onboarding and integration exercise that is required today.
Intermediaries, like Hedge Fund Administrators (HFAs), Third-Party Administrators (TPAs) or even large PBs, might be well suited for the creation of such utilities, which would work on a fee-based model and provide services to both Fund Managers and PBs. This utility could provide a number of benefits, including:
- Integrating multiple PBs onto a single platform
The utility will integrate with multiple PBs into their custom environment using the PB’s protocols and interfaces, removing the integration burden from the Fund Manager. The complex operational processes currently part of onboarding a new Fund Manager into a Prime Broker, or vice versa, will be undertaken by the utility. When onboarding another PB, the utility will create interfaces to access the transactional, positional and other information from the PB and perform additional analytics on it.
- Convenient access to multiple Prime Brokers for Fund Managers
The utility model requires one-time integration for the Fund Manager into the utility, after which the Fund Manager will gain access to all the PBs that the utility offers under its umbrella. Both PBs and Fund Managers will be able to avoid the burden of integrating multiple parties—a process that brings no financial benefit to either. PBs will no longer have the burden of integration, while Fund Managers will have a single channel to a broad market of PBs. As this model matures, it will provide Fund Managers ease of portfolio movement from one Prime Broker to another, increasing their accessibility to the market.
- Independently hosted technology
The multi-prime utility will host its solution on its own infrastructure. The utility will be responsible for maintaining that infrastructure and all operational processes involved, and will have clearly defined SLAs with both PBs and Fund Managers. It will utilize best-of-breed technologies for performing data integration, portfolio accounting, risk management, data management and reporting functions.
- Consolidated back-office functions across PBs
The utility will perform the back-office functions from PBs and Fund Managers. With the availability of aggregated positions across multiple PBs, the utility will be best positioned to perform risk management, portfolio accounting, reporting, compliance and similar back-office functions. Fund Managers will receive consolidated data and reports, while the PBs will be able to focus on core operations—instead of spending millions on commoditized post-trade services.
The Fund Manager/Prime Broker relationship is continuing to evolve with the changing dynamics of the marketplace. While Fund Managers are looking at diversifying risk and increasing revenue, PBs are focused on improving their service offerings. Meanwhile, both parties are spending considerable resources on integrating with each other and performing back-office functions that neither is well positioned to perform.
Both parties would be better served by investing those dollars to strategically address the new paradigm of a multi-prime marketplace.
A third-party multi-prime utility, offered by a Hedge Fund Administrator, third-party administrator or a large PB, that integrates with multiple PBs and provides single interfaces to Fund Managers, could be the solution to satisfy the evolving requirements of Fund Managers. In the long run, this will improve operational efficiencies, reduce integration expenses and help them regain focus on their core competencies.
Sudhanshu Bahadur leads the technology domain for Sapient Global Markets in Canada, Vishal Bakshi is a Senior Associate of Trading and Risk Management, and Valcony Sun is a Business Consulting Associate, specializing in capital markets, all based in Toronto.