HF Treasurers to Adopt RM Role As Regulation Hits Bottom Line

With regulation making financing for banks and hedge funds alike a more studious exercise in balance sheet management, the role of the treasurer is changing.

The role has evolved from one that is focused on collateral management, counterparty risk and financing to a more strategic with more emphasis on helping to maximize returns through increased transparency and partnership with counterparties.

These observations, contained in a whitepaper from J.P. Morgan, follow on from a previous study on the potential of regulation to constrain the availability of balance sheet for prime brokers and hedge funds. As a consequence, says the bank, the function of the treasurer is gaining in strategic importance as hedge funds concentrate increasingly on the optimization of balance sheet usage.

With the changing environment, hedge fund firms may enhance their treasury functions to play more of an advisory role, focusing increasingly on strategic alpha generation, i.e., maximizing efficiency and transparency to maximize returns for investors. The treasurer may come to serve as both the voice of the hedge fund complex externally with counterparties and as an internal mediator of competing investment teams.

The latest white paper, authored by J.P. Morgan’s prime brokerage consulting team, also draws on observations from the bank’s capital introductions and it’s own treasury team, who work with small and medium-sized funds in particular who may not have overly structured treasury functions.

The research classifies treasury functions along three different models with no one size fits all approach. However, it encourages hedge funds to check whether the model used is appropriate for the regulatory environment. While some have adopted simplistic checks and balances there may be a need for them to restructure their treasury functions, notes the white paper. It notes the industry, including sophisticated household names, are at the beginning of the cycle, with some clients beginning to restructure their treasury functions now before the real pressure will be felt, in 18-24 months.

For larger hedge fund firms, particularly multi-strategy, this may mean organizing and empowering treasury desks so that counterparty usage and financing costs can be allocated efficiently among their various investment teams and funds. For smaller or single-strategy hedge funds that do not have a treasury desk per se, it may be necessary for the COO or CFO – working in tandem with the CIO – to manage borrowing from, and payments to, bank counterparties so as to optimize investment returns.

As treasurers partner with financing counterparties to gain a better understanding of the strategic levers that are available to optimize balance sheet usage, they can work with their counterparties to make cost-effective (and, in some cases, costless) adjustments to improve returns on balance sheet within and among their prime brokers.

Treasurers should also focus on the allocation of balance sheet usage internally to try to maximize the franchise value of the firm as a whole, says the whitepaper.

In this regard, it observes three different hedge fund treasury models. In the first model, what it terms decentralized model (DM), allows each investment team to manage its own balance sheet usage in lieu of a cross-platform centralized treasury function. The second model, centralization with external optimization (CEO), makes use of a consolidated treasury function across the entire firm. Here CEO is largely agnostic regarding cost at an investment team or strategy level and seeks to represent externally the franchise as a unified whole. The third permutation, which we refer to as centralization with full optimization (CFO), represents more of a gradation on the continuum of centralization.

While DM may be appropriate for a single-strategy fund, a hedge fund may subsequently evolve to a more centralized model as it adds strategies and increases in scale. Conversely, a firm that only recently added a new strategy may start with a CEO-like model, benefiting from the synergies that might exist within such a structure. As the firm matures, though, there may be a natural progression to a more transparent CFO-like model, allowing the hedge fund complex to further optimize synergies at the investment desk level.

Treasurers should have the metrics to analyze its balance sheet internally and to ensure they are set up correctly to manage relationships with their prime brokers, the white paper suggests. Rather than investing in the treasury function it suggests the development of what is currently in place or sharpening up of the treasury functions at hedge funds. While it has seen this already among some of the larger funds it expects more consideration and more time given to hedge fund treasurers role.

For example, for a smaller firm using a DM, optimization by the treasurer can save money. The firm may have 10 portfolio managers each running different strategies with different core financing prime brokers. If their borrowing is not centralized through the treasurer or at the CEO level and is instead done at the portfolio manager level, the level of borrowing is determined by that portfolio manager and means that optimization opportunities resulting from having a broker, who is long and short in Brazil for example, are missed. A centralized structure might result in lower costs by putting all balances together while still allowing the PM to continue with their own strategies. This makes it easier for those firms that do not have MIS reporting and may not easily get a consolidated view of their financing relationships to see where they can optimize them.