Citi Prime Finance’s 2011 IT Trends & Benchmarks Survey
I
15
HF IT Investment
Resulting Differentiation
Commercialization of IT Spend
Complexity of Multi-Prime Model
Customization of Financing
& Collateral Management Systems
Financing/Collateral Optimization
Buy-Side Lending
Desks/Broker-Dealers
Proliferation of
Consulting Talent
Upgrade of
Vendor Offerings
New Industry Services
Increasing Availability of Hedge Fund Aligned
Financing & Collateral Management Systems
Emergence of AQS & Outsourced
Collateral Management Services
Retrenchment to Focus on
Core Investing Competency
Shifting Market Dynamics
derivative instruments. Hedge funds that had invested in these
capabilities were able to present their technology platforms as
offering them a competitive edge.
Other cutting-edge funds with more equities-focused strategies
were able to optimize their fnancing across their multiple prime
brokerage relationships. They sought to develop or customize
trading systems to be able to determine the cheapest counter
party from whom to borrow securities, looking at short locates
across a fund’s set of prime brokers and helping the manager
identify the best borrow rate. This led to many frms building out
their own internal fnancing desks which persist to this day.
The benefts achieved by early Wave 2 frms led some of the
largest funds to identify alternate uses of their fnancing and
collateral management-technology investments. Having built
infrastructures to support their own fnancing and collateral
optimization needs, they saw an opportunity to extend their
business model to seek cheaper fnancing directly in the
public markets rather than relying on their prime broker to
supply these functions. This was a highly attractive proposition
in the strong markets of the mid-2000s. To facilitate their
own fnancing, they had to become broker-dealers that could
go directly to public sources or to other funds to lend and
borrow securities.
These frms would move positions from their master fund
to their internal broker-dealer that would then use those
assets to raise money in the public markets. To support these
activities, the hedge funds would typically leverage their own
platform, building additional customizations instead of using
vendor solutions designed for the sell-side that were industrial
strength and expensive. The hedge fund frms would connect
their proprietary platforms to the same industry standard
networks the sell-side used for enabling their public fnancing
(i.e., Sungard’s Loanet for securities lending and the primary
dealers for repurchase agreements—Citi, JP Morgan and Bank
of New York). Clearing would often be outsourced, though the
largest funds would occasionally take on this burden themselves.
Signs of Wave 2 Commoditization Emerge
Commercialization of these buy-side built “broker-dealer
fnancing platforms” may have gone even further, but the
severity of the 2008 global fnancial crisis caused interest in such
capabilities to decline dramatically.
Liquidity concerns and industry-wide de-leveraging in the wake
of the 2008 crisis made it much more expensive to obtain
fnancing via the public markets. Firms that had built extensive
infrastructures to support this business found themselves trying
to maintain an expensive cost base with lower management fees
and fewer assets under management. Under such circumstances,
it became clear for the majority of these frms that the
technological, operational and regulatory overhead associated
with being a broker-dealer was no longer worth the trouble once
the business cycle was disrupted by the crisis of 2008.
Many of these frms then retrenched, closing down their
broker-dealer operations in a move to save costs. They returned
their focus to optimizing their own fnancing and collateral
management.
Chart 9: Wave 2 Hedge Fund Investment Cycle