Sam AuxierThe major themes in 2009 for fund administrators and utilities are familiar ones--hedge fund servicing and derivatives processing will be the top issues service providers expect to help their clients solve. This year's plans, however, will be overshadowed by uncertainty, at least in the first half. "I think caution and fear are probably the words of the moment," said Sam Auxier, director in the regulatory and capital markets practice at Deloitte & Touche.
Sam Auxier
Derivatives processing has garnered more attention from regulators over the past year, particularly as major counterparties have failed. Hedge funds have taken hits over the past year as well, losing confidence in prime brokers and turning toward more established providers who will scramble to keep up with their demands. Efficient collateral management has emerged as a surprise focus; though always important, current events have illustrated why the function is necessary in fast-moving markets.
Hedge Funds To Expand Traditional, Outsourcing Services
One major change service providers are expecting this year: hedge funds that are more likely to contract traditional providers for administrative and custody functions. But, hedge funds are also expanding the types of services they request from traditional providers, which means in some cases providing non-traditional services, said Marina Lewin, managing director of alternative investment services at The Bank Of New York Mellon. In some cases, this will cause administrators to move into what is traditionally considered prime broker territory. "I think we will see a redefinition of the prime broker model, so the definition of what service providers are doing for alternative firms will continue to evolve," she said, noting there are more and more demands on the bank to provide short term cash management, facilitate tri-party repurchase agreements and manage collateral.
Cary StierCary Stier, U.S. head of asset management services for Deloitte & Touche, said the effect will be more detailed service agreements. "It will be interesting, because you may see a consolidation of hedge fund administrators, and prime brokers and different banks merging that offer different services. We will see changes in general for service delivery, so I would expect changes to some of the agreements."
Cary Stier
No More Gentlemen's Understandings
Some of those changes are expected to impact collateral agreements. Stier said many funds struck basic agreements with prime brokers. He characterized it as a "gentlemen's understanding," that if a fund were overcollateralized, it would not call back collateral but retain control. In light of the failure of Lehman Brothers, those understandings will go out the window in favor of legal agreement and tighter control. Jon Anderson, global head of over-the-counter derivatives at GlobeOp, said the independent administrator provides the function for funds, and the firm is getting more business because of it. "The number of collateral calls is going up. There is also a heightened interest in getting accurate collateral rates," he said. Anderson noted the firm has seen new clients coming to the firm specifically for the function and the trend is expected to continue.
Outsourcing has also cycled back into favor among hedge funds, especially as hedge funds have been pressured by lower revenues, the needs of institutional investors and appeasing regulators. Deloitte's Auxier said it is expanding beyond the functions traditionally sought after. "Now, they are almost looking for a larger IT and risk functionality to be built into the service, and [they want] operations along with that," he said.
Peter Cherecwich, chief operating officer for Corporate & Institutional Services at Northern Trust, said the need was similarly strong in the early 2000's during the last major downturn, but some firms, including Northern, weren't prepared. "It's seven years later and we have product built out and are ready to go. We still have to invest and we still need to build out, but we are very optimistic about our business line," he said.
Derivatives Operations In Focus
U.S. regulators that have stopped just short of mandating central counterparty clearinghouses. The platforms supported mainly by U.S. participants are expected, with major dealers committed to their launch and use by the end of 2008, though, by deadline, none had received final regulatory approval to launch. European platforms have also been proposed, and the European Commission has began to push publicly for the launch of clearinghouse platforms.
The effect on existing providers, particularly existing utilities, is unclear, though some envision playing a role. Ignace Combes, deputy ceo of Euroclear, said one option in Europe might be to incorporate central clearing for derivatives into a user driven offering to reduce risk and link it to other related services, such as triparty collateral management. Currently, the activity would be outside of Euroclear's scope, Combes said, but, he added, "we emerged from the turmoil and tsunami unscathed, so maybe the users and the regulators will look to use the utilities in more areas of securities processing and particularly look for synergies across services being fully leveraged." Combes noted that with pressure on costs and the urgency with which options are being considered, existing platforms may be a better option than capabilities built from scratch.
Mark BeestonOther initiatives are also in progress related to derivatives, namely the move to electronic novations platforms, which will hit its final implementation milestone by Feb. 28. Mark Beeston, president of T-Zero, which offers one of two approved platforms for the function, said he expects most firms--with no more than 15% of participants as laggards--to be on an electronic novations platform by the deadline or risk entering more transactions and taking on more counterparty risk. Joseph Amarante, senior v.p, of professional services for consultancy Northpoint Solutions, said hedge funds are really focused on making the move. "There is a big push from a lot of firms to get that in place. We are working with a few clients now to get them well integrated with [the Depository Trust & Clearing Corp.]... to get that process automated," he added.
Mark Beeston
Beeston said the novations process is just a first step of three toward a final process. Electronic communication of allocations and giveups to the clearinghouses are the other two pieces that will be required of firms, though there are no hard deadlines. "The adoption of electronic communications tools is really, in my mind, a stepping stone to achieving other objectives, as well as to get the industry to a place of total scalability," he said.