Over the past 4-5 years world economy has seen some significant changes, these changes were not because of the crisis that debacled the global economy but also because of other parameters like regulations , transparency etc. When i say global economy has seen significant Changes it not only refers to the changes in financial markets but also in other industry . There is a shift of focus on “COST” . Earlier markets being good the firms were not much restricting themselves in terms of cost. Obviously if you are earning well you would not mind spending and expanding. With the crsis looming and the world financial markets seeing distastes like Lehman Brothers , Bears and Stern , Merrill Lynch , this made the investors , fund managers thinking caps work.
This was the time which required innovative thinking and having a new model in place which would not only save the investors and market makers from the risks of crisis which were looming on to the world economy but also give them a wide verirty of options to choose the services . It was time which required a innovative model/ products in place which would help shareholders/ investors. This let to a shift from a single prime broker model to a multi prime broker model.
The focus of this blog is to highlight the fact that how the hedge fund managers have shifted from one model to another. We are typically refering to a shift from a single prime broker model to a multi prime broker model. Now what a single prime broker model would typically mean is , a hedge fund would have one prime borker providing all services right from security lending to risk management and alpha generating trades. Since the financial markets turmoil started there was one thing which was very prominant ” Risk” . The one we are refering to here is the counterparty Risk . Being in a single prime broker model a hedge fund would always have a high counterparty risk.
Now with Multiple Prime Broker model coming into picture the first question that comes is who needs it ? and Why ? Now that intially was thoought that any Hedge fund whose size is less than $ 1 Billion would follow single prime broker model and aove that would go for Multi Prime Broker model. But as the crisis in markets deepend further. This led to more or less every hedge fund following a multi prime broker model regardless of its size.
Now Why a multi prime broker model is required can be answered by the benefits of multiprime broker model.
- Diversification of counterparty risk among multiple brokerage firms and investment banks.
- Increased access to securities lending programs and competitive financing rates.
- Multiple execution platforms and increased opportunities across global markets
- Greater transaction capabilities within OTC asset classes and loan markets
- Expanded capital introduction networks
- More comprehensive research capabilities
- Access to ever-growing product and service
- offerings within multiple prime brokerages
How to Make Multi Prime Broker model work for a Hedge fund ?
It requires both infrastructure and best business practices to maintain control over the data .
1.Contact other market participants to determine which prime brokerage services best suit your individual needs. Discuss how other firms have prioritized,implemented, and managed these changes and which, if any, additional resources they utilized.
2.Gather feedback from the various constituents within your firm to fully consider data consumption needs such as reporting, reconciliation, and real time feeds, and implement a framework for consolidating data across the various counterparties.
3,Review internal processes to reconcile and remediateerrors with consideration to data sources andcommunication methods. When using a single-prime model, firms often passively accept data or reconcileonly when things look off. As a firm expands its use of counterparties, the increase in transaction sources and position data demands more thorough reconciliation and timely error correction. This necessitates the fund to develop a more robust reconciliation framework.
4.Establish operational metrics, such as aging of unreconciled positions or dollars spent on trading and hedging errors. Utilize these metrics to ensure the move to multi-prime is being handled correctly from an operational perspective. These metrics can also help a fund capture and resolve inefficiencies before expanding transaction volumes in those areas.
5.Define the appropriate risk reporting framework, including existing reports available from your prime broker, vendor packages, and internally defined risk alculators. Determine a methodology to feed multiprime data into your risk framework.
6.Negotiate service levels and methods of counterpartycommunication prior to signing on.
7.Build out the necessary allocation methodology and internal procedures for allocating trades among the various prime brokers.