Part II of 5th Annual Hedge Fund Survey Examines Resulting Financing
“As the demands of the new regulatory environment emerge, market leaders need to build out new capabilities, platforms and processes to survive and transform their organizations,” said
Regulatory Overhang Leads to Financing Overhaul
The exit of proprietary trading from sell-side organizations has allowed key aspects of market-making, inventory management and direct lending to shift from a dealer-dominated activity to one where major hedge funds have a key role in taking on market risk.
Moreover, there is a collateral conundrum in that there are more strategies being executed than ever but less financing available. The pool of collateral that hedge funds control is likely to continue to expand which could lead hedge funds to begin treating collateral as an asset class with which they can supplement their trading book profits.
Optimizing Counterparty Management and Relationships
Hedge funds will need to overcome numerous challenges as the number of collateral pools expand exponentially, further magnified by the introduction of Dodd-Frank and the EMIR OTC derivative rules. To optimize counterparty interactions, new data inputs, analytics and tools will be required to support the effective use of hedge fund collateral assets and efficient deployment of financing positions.
Leading hedge funds are further evolving their scorecards to measure the value of their financing wallet allocation with their key counterparties. Determining the right metrics to track their engagement with the sell side will become a critical component of counterparty management. The cost of financing is also likely to rise as Basel III liquidity coverage ratios negatively impact prime broker balance sheets and force broker-dealers to re-price their offerings. Hedge funds that move from a service-based to a relationship-based model with their counterparties are likely to have better access to financing and realize less extreme price increases.
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