Opalesque - Other Voices (Matthias Knab) : The operational challenge of multi-prime brokerage - July 24, 2008
Title: Other Voices: The operational challenge of multi-prime brokerage by Matthias Knab (Full article available at www.opalesque.com)
Peter Curley, Managing Partner at Nirvana Financial Solutions, has published a thought leadership White Paper entitled "A Flat World, Multi-Prime and the One Path to Nirvana". It deals with the very topical issue of hedge funds going multi-prime. In particular, it explores why hedge funds are forming multiple-prime brokerage relationships and how these firms overcome the operational challenge involved with going multi-prime.
The Multi-Prime Requirement of a Flat World
The industry's most important service provider and the provider that most defines today's infrastructure is the prime broker. The model that has emerged is one of a single captive relationship with a hedge fund. The single prime provides everything that a domestic long/short equity fund requires to get up and running. These services include custody of assets, stock loan, financing, trading, trade ideas, capital introduction, office space and all their operational needs including an outsourced front, middle and back-office. In return the prime earns lucrative fees ($11 Billion in revenue for 2007) for stock loan, financing, and to a lesser extent, trade execution. Funds were satisfied with this model because, in many cases, there was no great difference in the services offered by the primes required to support the needs of a domestic long/short equity fund. Only when the fund matured well beyond its start-up phase did it consider adding more prime relationships. This move to multi-prime was not made with any great haste and was generally motivated by more competitive fees and a desire to appear more 'institutional'.
The industry is now experiencing a transition, with the single prime captive model giving way to a new model, where funds are looking to form multiple prime broker relationships much earlier in their life-cycle. Setting aside the recent acceleration towards multi-prime caused by Bear Stearns and the very real subject of counter-party risk, the macro trend driving funds to this new multi-prime model is the urgent need for new alpha opportunities. In this increasingly complex world, funds are discovering that there are real differences in the services provided by individual primes and that no one prime has the ability to service all the demands of today's global funds. Prime brokers' regional and domain expertise in the areas of stock loan, market access derivatives, trading ideas, are now critical to a fund's ability to uncover alpha and are leading to a more specialized prime broker industry. While we will never get to a situation where a fund's prime broker relationships will be as numerous or as transient as it's executing broker relationships, we are now entering a world where the prime relationship will be more closely tied to a fund's specific alpha opportunity than ever before.
The Operational Challenge of Multi-Prime
Once a fund accepts the necessity of multiple prime relationships there quickly follows the realization that there is a cost associated with this new model...
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