Prime brokers are investing in smarter systems to manage risk and collateral across multiple asset classes. Frances Maguire looks at how far this ability to mark-to-market in real-time will go.
Cross-asset trading and risk management are not new – the terms have been around for some time. Neither is it rocket science to take away the product silos and achieve a single aggregated view of risk in one portfolio. And yet, achieving it and fine-tuning it is taking longer than expected, because of the need to replace legacy systems and build new technology.
Jesper Bang, head of prime brokerage at Dresdner Kleinwort, says the ability to be margined on a portfolio basis, across asset classes, has been of increasing interest to hedge funds over the past few years as the long/short equity funds get involved in other asset classes, such as listed products and over-the-counter options, combat direction systems and bank loans, and need an efficient margining process across the assets.
He says the real benefits of true cross-asset class margining are really gained on fixed-income and credit-related bonds, such as long bonds, and short futures versus interest rate swaps, which are traditionally much more leveraged and where any true offsets in a portfolio would be recognised.
From the hedge fund perspective, the drive to build multi-asset class portfolios is to get the optimal use out of their collateral. In addition to the netting, if they can also achieve the offset – the recognition of any hedging transactions – that is a huge benefit to the hedge funds.
But according to Mr Bang the term has been mis-sold, and mis-represented in some cases. “There are very few prime brokers that are actually offering a true cross-margining product where they are offsetting trades, rather than just netting, and Dresdner Kleinwort is one of the few houses that do that.”
He says that one of the advantages Dresdner Kleinwort had was that it was relatively late to join the game. Starting its prime brokerage business in 2001, it quickly recognised that it had to take all the asset classes into consideration, and because there were no legacy systems it was relatively easy to implement true cross-margining by building it from scratch. Mr Bang says: “Dresdner Kleinwort went live in early 2007 with a true cross-product value-at-risk solution, in addition to the cross-netting product, which it had from day one. “Other prime brokers are trying to get there but it is a huge task because of the complexity of getting the products in from different legal entities and different systems.”
Greater complexity
Steven Cowcher, head of prime brokerage sales at Dresdner Kleinwort, says that the trend is being driven by the hedge funds as there is no such thing as a pure long/short equity fund and the world is becoming a more complex place for all managers, hedge funds and service providers. He says: “Hedge funds do not want to have to deal with the different desks but have them all managed and administered from a central account and have the value in those positions recognised within the account and cross-margined.” The goal, Mr Cowcher adds, is efficient use of capital as their strategies become more sophisticated and complex. The prime brokers can also identify risk-offsetting positions if they move away from the silo model.
Mike Brian, director and head of prime brokerage, Europe, at Barclays Capital, says prime brokers built their offerings around cash equity platforms, but BarCap differentiated its offering as a provider to multi-asset class hedge funds. “Increasingly, hedge funds are looking to trade multiple asset classes and use a combination of cash and derivatives products,” he says.
Looking back
The initial launch of BarCap’s multi-asset class product was in June 2000, offering bond futures, interest rate swaps and government bond repos, which were netted together for customers. Alistair Smith, director and head of Global Netting, and European head of derivatives prime brokerage at Barclays Capital, says: “This was very attractive as it was just after long-term capital – everyone was asking for haircuts on trades so the fact that we created the ability to net across all of those meant that we could charge a margin that fairly reflects the entire risk across the client’s portfolio.”
Mr Smith says that the information available to Barclays Capital for the management of risk is now much more comprehensive, and the multi-asset class strategy has also led to more risk-diverse portfolios. The benefits of netting mean that hedge funds are using a wider range of transactions as it makes sense to execute and clear more trades with BarCap and centralise their business.
Decision making
“We have been through several market crises over the past seven years and have much more comprehensive information to enable better decisions to be made, and because we offer this netting capability we have encouraged customers to transact more diverse, better hedged portfolios with us rather than ending up with just one side of the transaction. With a more diverse portfolio that includes long and short positions, rather than just lots of long positions, there is a lot less volatility in a time of crisis,” he adds.
Gurpreet Dehal, director and COO of Merrill Lynch’s financing division within EMEA, with responsibility for the risk and margining in the region, says that the broker’s customers have been trading across asset classes for many years. However, he does not believe that there is a race to build the ultimate multi-asset class trading system. In fact, he is not sure that such a system even exists. “Specialist instruments in each asset class will always require a specialised trading system. Where there is more of an interest, and where the next level of service lies, is how these transactions and resulting exposures are aggregated.”
New perspective
He says it is not a multi-asset class system that is needed but the use of technology to pull all exposures together and provide a single aggregated view for the client, with intelligence around the risk management of these exposures and associated collateral calculations.
Mr Dehal adds: “I think it is all about obtaining a consolidated view of these exposures within a central reporting platform – that is where there the winners will be in the next generation of systems. Transactions carried out with other firms should be part of the overall picture – the inclusion of give-ups across all products is the next key area we aim to improve on.”
Hamish Purdey, director at FfastFill, provider of application services for trading and risk management on electronic markets, says that the firm is building cross-asset class connectivity for derivatives, foreign exchange markets (FX) and bonds. Ffastfill already offers trading in bond futures, on both Eurex and Chicago Board of Trade, accesses the BrokerTec market in the US and is looking for access to the other cash bond platforms, both in Europe and the US.
He says that with cost-down pressures within institutions, leveraging the existing technology infrastructure to provide more content is becoming more of a requirement. Access to pools of liquidity in other instruments is becoming easier. The launch of FXMarketSpace, for example, and other aggregating tools are giving easier access to the bond market so that firms are able to push out from a more traditional futures base to FX and bonds.
Moving on
Cross-asset trading, risk and margining began between equities and FX, and then moved to derivatives and FX. “Integrating the technology silos for derivatives and equities makes a lot of sense, but FX, bonds and futures are the first three that many are looking at in the multi-asset class space,” he says. By the end of January, Ffastfill will announce a new release with significant FX functionality, and is providing aggregated real time mark-to-market of current market positions to a number of prime brokers.
Mr Purdey says the endgame is to have one risk management system that holds a complete portfolio regardless of where it is traded, and which asset class. “At present, this is very difficult because all of this information is in different systems, so if a prime broker has a customer that trades FX and futures, it cannot mark-to-market the real time position,” he says. “However, it will be a slow revolution as there are so many incumbent systems, but real-time mark-to-market risk management is now readily available, with feeds to and from the back office.”
There is no doubt that all prime brokers should be looking at real-time, multi-asset class, mark-to-market risk manage- ment systems, but it is the ones which can break free of the silo-models first, or build an integration across the asset classes quickly, that will win over.
