FT REPORT - FUND MANAGEMENT: When monogamy isn't on the client's agenda

By Peter Guest, Financial Times
Published: Jan 14, 2008

Dresdner Kleinwort came late to the prime brokerage game, launching in 2001, and soon recognised that its relationships with clients were unlikely to be monogamous. "At DKIB we've taken a view that most of our clients will be using multiple prime brokers and we have built an infrastructure that is very hedge fund user-friendly," says Jesper Bang, head of prime brokerage at the bank.

Industry participants ascribe various reasons for this decision to move to a multiple prime model.

Mr Bang believes it is primarily an operational concern. "We've seen hedge fund groups grow larger over the last few years, and with the pension funds pouring money in . . . hedge funds simply have to diversify their funding and service counterparties," he says.

After the turmoil of summer 2007, when margin calls by prime brokers reputedly left some hedge funds struggling, this requirement has become more crucial, says Mr Bang. "With the funding squeeze that's been in the marketplace, it's been very important for some of these hedge funds to have a number of service providers to go to just in case one of them stops providing liquidity. That would be devastating and it would be a big risk for the investors."

"The other key issue is around the prime broker's capability in particular segments of the marketplace," says Rory Gage, a consultant at Morse. "Often I find that seems to be the driver for prime broker selection.

"But I think very much in the back of many fund managers' minds is the nagging feeling of 'do we really want to give up our book completely to our prime broker?'," he adds. "If you talk to most fund managers, they definitely don't want to show their whole book to one prime broker."

Justified or not, he says, concerns about consistency of Chinese walls remain.

Scott Alderson, president of Paladyne Systems, says Dresdner Kleinwort is not alone in recognising its clients' desire for multiple prime brokers. "We've seen many of the prime brokers start to offer broker-neutral technologies," he says.

The ability to provide aggregated reporting from multiple prime brokerage relationships has in the past proved a challenge, particularly for clients of the largest prime brokers, such as Morgan Stanley and Goldman Sachs, who had taken responsibility for a lot of the client's infrastructure, Mr Alderson says. "A lot of their clients made it very difficult to add on a second prime because the client would have to build their own technology infrastructure in order to get aggregated reporting.

"For some of the larger clients Morgan or Goldman might do something known as 'hearsay reporting', where they would agree for their larger and more strategic client relationships to provide that aggregated reporting function, but it wasn't a readily available service."

Recognition of the trend is one thing, but offering a multi-prime platform has its own problems. "If a hedge fund manager leverages a multi-prime technology platform from a bank, they don't want all their positions inside the bank," Mr Alderson says. If the client wants to get aggregated data from all its prime brokerage relationships through just one broker link, it faces relinquishing the advantage of using multiple brokers to avoid conflicts of interest.

Two recent deals, however, show that some in the industry may have come up with a neat sidestep. Credit Suisse and Citigroup entered into strategic relationships with third-party vendors - Paladyne Systems and Linedata respectively. Branded by the investment bank, they provide front-to-back IT services and a single link from the hedge fund to its many brokers, but the investment bank will not see all the fund's positions.

This kind of relationship seems to manage the dichotomy between hedge funds' increasing demand for more IT and consultancy services from their prime brokers, and their wish to be less dependent on a single relationship. The big prime brokers seem well-positioned to take on a "prime of primes" role, if they can overcome qualms about funnelling business to competitors.