Prime Brokers Missing Opportunities In the US and Europe

Prime brokers in the US and Europe are failing to maximise the huge commercial opportunities in the hedge funds industry worth $500bn in the US and $75bn in Europe in 2001 due to poor levels of operational efficiency, according to

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Prime brokers in the US and Europe are failing to maximise the huge commercial opportunities in the hedge funds industry – worth $500bn in the US and $75bn in Europe in 2001 – due to poor levels of operational efficiency, according to a new report by London based TCA Consulting. The report, based on a survey conducted by TCA Consulting at Economist Conferences’ Third Annual Investment Forum: Hedge Funds*, found that while accuracy and timeliness of reporting is key to prime brokerage services, less than 20% of hedge fund respondents questioned by TCA Consulting were completely satisfied with the accuracy of their reports.

The report argues that prime brokers need to collate information across a range of products to report to their hedge fund clients. But this means that they have to deal with many disparate systems, tools and markets, and without integrated IT, prime brokers are struggling to provide accurate reports. The information received is therefore neither reliable nor flexible enough, raising prime brokers’ costs whilst decreasing the confidence of their hedge fund clients.

Sandra Williams, Principal Consultant at TCA Consulting and author of the report, commented: “Wholesale banks have become more and more specialised in their business with the separation of equities, derivatives, securities etc. causing a silo effect whereby each department has its own IT infrastructure. These expertise silos can serve the bank well, but hedge funds use products across the bank – so prime brokers need cross-silo information for risk management and competitive financing provision as well as for reporting to their hedge fund clients. A lack of integration means that prime brokers spend a great deal of their time collating and processing data – time that could be more profitably spent selling their services. One of the hedge fund respondents surveyed actually complained of a lack of sales calls from his prime broker!”

Lack of operational efficiency and STP

The results also concluded that nearly half of all hedge funds regard operational efficiency to be key in their selection of prime brokerage services. However, the research found that prime brokers are currently working with poorly integrated systems and a limited degree of straight through processing, with little over 30 per cent of hedge funds questioned having global straight-through processing (GSTP) between themselves and their prime brokers in some key areas such as trade confirmations, trading and execution. This rises to just over 65 per cent in settlements. Sandra Williams commented: “Prime brokers should not underestimate the importance of STP. They are missing opportunities to reduce both their costs and their level of operational inefficiency, and so are unable to provide their hedge fund clients with the accurate information they need. This is a lose/lose situation – in an expanding market, prime brokers are sacrificing competitive advantages. They need to take time to select and implement STP for everyone’s benefit.”

Opportunities for greater service differentiation

Timely, relevant corporate event information is a key factor in a hedge fund’s trading decisions. However, less than half of the hedge funds questioned were completely satisfied with information received on corporate events in their investment universe, while others complained about lack of information on settlement dates. Several commented that they could not rely on their prime broker to provide corporate action information and sourced it separately. Sandra Williams said: “That hedge funds should have to source corporate actions information independently should serve as a warning of missed opportunities to prime brokers. With the advent of reliable, cleansed data, and messaging standards such as ISO15022, it is now time for prime brokers to positively reassess their corporate actions operations and provide a more efficient and informative service.”

This lack of properly integrated systems also has significant consequences for operational risk. Hedge fund clients rely on their prime brokers to facilitate settlements and process corporate actions, both of which carry high levels of operational risk. Prime brokers are therefore on the front line when it comes to absorbing the operational risk associated with the failure of these processes. A more advanced level of IT systems integration would thus allow prime brokers to reduce their operational risk, and make them more attractive to potential hedge fund clients.

Sandra Williams concluded: “The growth of the hedge funds market heralds golden opportunities for prime brokers. However, increased competition will mean that new and existing players alike will have to reassess their services to provide real operational efficiency and fully maximise the scope of opportunity in this expanding market. “