Securities Services
Regulation will shape prime custody models of the future
As the investment banking industry remains in crisis and counterparty risk and financial strength come to the fore, hedge funds are looking at custodian banks in a different light.
In the wake of the 2008 financial crisis and the wealth of regulation alternative investment managers now face in the form of Dodd-Frank and AIFMD (Alternative Investment Fund Managers' Directive), hedge funds are starting to look at another group of service providers - custodian banks.
The debate about prime brokers versus custodians is not a new one, however, in a paper entitled, ‘Filling the Void: Transparency and the Rise of Custodian Banks,’ Brian Ruane, CEO, Alternative and Broker Dealer Services, BNY Mellon, says "With investment banks and fund managers in crisis, the universe of companies providing key services to hedge funds has dramatically shifted, and a door has opened. Hedge funds gained a new appreciation for counterparty risk and financial strength and started to look at another group of service providers - custodian banks."
Following the 2008 financial crisis, Ruane says hedge funds in the US "sought out" custodians to safekeep and service their cash and securities. "Services traditionally reserved for prime brokers, such as clearing, cash and collateral management, became components of a service partnership between primes and custodians," he says.
In Europe, historically few hedge funds maintained direct relationships with custodians. That was the job of the prime broker. However, Ruane says this model is being challenged by the need for greater "asset protection" and hedge funds are also showing interest in using custodians, not just for collateral services, but also custody services, similar to the US model. “Alternative investment managers in the U.S. and Europe, as well as the more institutionally focused managers in Asia, are looking to custody banks as financial intermediaries who can deliver a seamless offering.”
In the US, he says several prime brokers have created partnerships with custodians and that interest is expanding to Europe as well. Where applicable, custodian banks have also sought to work more closely with the investment banking side of the business to tie custody and prime brokerage more closely together.
Ruane argues that the biggest driver for change to existing prime custody models is regulation. In the US, he says the SEC published its position on Assets Held Away from prime brokers, which highlights regulatory concerns regarding "broker liquidity". "Such regulatory developments underline the need for strong networks of support banks and institutional investors," writes Ruane, " who will endorse the terms in tri-party account control agreements and honour those agreements during a control event."
Date Posted:5th October 2011