Making Multi-Prime Work
January 5, 2009
Investor assets and returns can no longer remain vulnerable to the risk of the single-prime-brokerage model. To effectively manage business and thrive in today's rapidly evolving market, it is imperative that funds establish relationships with multiple prime brokers to mitigate potential risk and better manage transaction costs.
Historically, most hedge funds with assets greater than $1 billion have operated in a multi-prime environment while smaller funds used a single-prime model to simplify their operations. Today, however, funds of all sizes are taking a multi-prime approach.
Expanding prime brokerage relationships gives funds access to more products and services while reducing risk. Key benefits include:
* 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 over-the-counter asset classes and loan markets;
* Expanded capital introduction networks;
* More comprehensive research capabilities; and
* Access to ever-growing product and service offerings within multiple prime brokerages.
These new prime brokerage relationships can offer significant potential to a fund, but they must be managed effectively in order to fully realize their benefits. Going multi-prime means that a firm will need to build the infrastructure to consolidate position, transaction, cash and exposure information into a single reporting platform.
While some prime brokers are providing basic hearsay reporting services, few firms are eager to go this route as it introduces the potential for inaccuracy when information is shared between multiple service providers.
To maximize return on investment when moving to a multi-prime environment, hedge funds will need to develop both the infrastructure and business practices to maintain controls over their data. There are several key points a fund should consider:
* 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.
* 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. As the CTO of a multi-billion-dollar hedge fund told my company, Advent Software: "It took us over six months to figure out everything our prime broker had been doing for us. I wish we had a better understanding of our real needs before we got started."
* Review internal processes to reconcile and remediate errors with consideration to data sources and communication methods. When using a single-prime model, firms often passively accept data or reconcile only 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 that the fund develop a more robust reconciliation framework.
* 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.
