Deloitte launches networked enterprise hedge fund model

Date: Thursday, August 13, 2009
Author: Hedgeweek.com

Deloitte has launched a networked enterprise hedge fund model that offers a framework for the industry to manage risk and remain profitable as the roles of prime brokers and third-party administrators evolve.

"As investors demand increased transparency and operational risk management, hedge funds are faced with redefining their relationships with prime brokers and third-party administrators. The industry requires a sophisticated solution to respond to this new operating paradigm, which involves tremendous complexity and increased infrastructure demands," says Cary Stier (pictured), Deloitte's US asset management services leader. "Deloitte's networked enterprise model offers hedge funds a holistic operations strategy built on managing relationships - a focus that mirrors our own commitment to client relationships."

A report by Deloitte, entitled Evolving Operating Models within the Hedge Fund Industry: How Hedge Funds Are Becoming the Ultimate Networked Enterprise, outlines five areas of focus and discusses the implications of the networked enterprise model for both prime brokers and third-party administrators.

It says hedge funds need to determine their optimal operating strategy and factor in roles various service providers will play in providing necessary capabilities. Although most large firms will build their own middle-office, service offerings from fund administrators and custody players will prove to be compelling from both a cost and capability standpoint. Managing the network of service providers will require additional capabilities that the hedge funds will need to build and staff in-house.

The report says the multiprime model will only increase the need for improved collateral management. Some hedge funds will benefit by outsourcing to enterprise collateral management service providers or implementing vendor solutions to efficiently manage their collateral across various parties. In addition to spreading collateral across parties, independent valuation of illiquid assets, zero over-collateralization and optimal collateral composition will be the key focus areas.

According to Deloitte, risk management will see a balance of focus between market risk for investment strategies and counterparty risk. In a multi-prime model, a single broker's risk report will show only a partial picture of the risk profile. Risk management will need to be a central function that aggregates positions across all providers.

It also states that the choice of prime brokers should be guided by aligning the fund manager's needs to the prime broker's capabilities - balance sheet strength, execution platform, geographic presence, flexible financing/margining options and product coverage.

Third-party administrators can help hedge funds outsource several middle- and back-office functions, according to the report. With the increased complexity of the middle- and back-office, hedge funds should at least understand the range of services available from their administrators.

Prime brokers are experiencing a major shift in their business model, says Deloitte. Their focus on developing deep relationships with a few hedge fund clients is no longer working in a multi-prime environment, where risk diversification and access to capital is taking center stage. As lending stays constrained, prime brokers will be required to improve capabilities to deal with new clients and existing capabilities may lose favor among the hedge funds adopting the multi-prime model.

It adds that third-party administrators are being challenged by handling increased product complexities, technology scalability and international growth. While hedge funds outsource middle-offices and evaluate ways to reduce costs, third-party administrators will need to cut costs and potentially look into moving their back offices to cost-effective locations. Some may offer prime broker-like services to improve profitability and further increase competition in the market or go global; others will more closely align with custodians or consolidate for scale.