Andrew Baker

18/01/2012 Author: Andrew Baker

Comment: Andrew Baker

Aima continues to devote significant resources to the production of industry tools such as guides to sound practices and due diligence questionnaires (DDQs). An Aima working group including senior executives from some of the world’s leading prime brokers has just produced an updated illustrative DDQ for prime brokers and a new Guide to Sound Practices for the Selection of a Prime Broker.

They are aimed at hedge fund managers who wish to select a prime broker, whether establishing an initial relationship or in choosing an additional prime broker for their business. The guide to sound practices should also be useful to hedge fund managers who periodically review existing prime brokerage relationships from a service, risk, diversification, value or cost perspective.

The DDQ, a revision to the 2007 edition, updates the sections relating to financing, securities lending, margin, settlement and custody, asset servicing and protection, synthetic products, exchange-traded derivatives, FX prime brokerage, client services, consulting and cap intro. New sections dedicated to central clearing and OTC clearing have been added, reflecting global regulatory changes related to derivatives contracts. The DDQ also addresses issues relating to the choice of platform.

The release of both publications comes amid an evolution in the relationship between prime brokers and their hedge fund clients.

The working relationship between the manager and the prime broker is just as important as it always was. The best prime broker account managers have an exceptional understanding of their client’s business needs; are able to facilitate timely responses to financing and prime brokerage requirements; and co-ordinate effectively with all of the other internal service desks, such as trading and sales.

But managers today expect more, beginning with reassurances about the health of the prime broker and, where relevant, its parent group. As the guide states, managers need to know their prime broker is adequately capitalised and has a proven track record of navigating turbulent markets. The guide states managers should give careful consideration to the financial standing of the prime broker and its parent group by using a variety of counterparty risk measures, such as its credit rating, liquidity governance and diversification of its business. In addition, reference checks should cover how a prime broker behaved or treated its other clients in times of previous market stress, and how it has responded to tighter regulatory scrutiny.

Managers may also choose to use more than one prime broker. After the bankruptcy of Lehman Brothers, when scores of hedge funds had both cash and securities frozen, counterparty risk to a single financial institution is now at the forefront of every manager’s (and investor’s) mind. Hedge funds also are keen to tap into the competitive advantages of different prime broker offerings, which can only occur if multiple relationships are maintained.

Yet while the relationship between a fund and its prime broker or brokers has undergone great change since the onset of the financial crisis, a constant has been the enduring spirit of partnership between hedge fund managers and prime brokers that underpins it, as borne out by the collaboration between Aima and a dozen of the leading prime brokers that has produced the guide and the DDQ. These documents, along with the full range of Aima’s DDQs and other sound practices materials, can be downloaded by Aima members at www.aima.org.

Andrew Baker is CEO of Aima, the Alternative Investment Management Association

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