International Hedge Fund Operations: The Prime Broker Perspective

By Mary Beth Hamilton | Tuesday, September 7th, 2010

In a previous article we looked at some key aspects of expanding a hedge fund's operations internationally including the business and technology factors. Overseas expansion requires a number of strategic considerations. One of the most important steps a hedge fund must take in beginning the international expansion process is to understand the local government requirements for establishing a new business in the selected region.

Once a hedge fund manager understands the local regulations, he must look to leverage his partners and key vendors to help facilitate international expansion. A hedge fund prime broker is a key ally when establishing international operations.

There are several significant factors that should be taken into consideration when selecting a hedge fund prime broker. A hedge fund wants a prime broker who will help it grow, and the easiest way to do that is to make sure both the hedge fund and the prime broker understand local regulations. A hedge fund places a lot of trust into a prime broker; therefore, it should verify that the broker understands the international investor marketplace. The prime broker should be adjunct to the firm’s own marketing efforts. It is important for a prime to know what a good match for a firm is.

From a custodial perspective, a hedge fund should ask several questions. hedge fund globe image

Does this prime broker cover every market?
Does it use sub-custodians? If so, who are they, and how much more do they cost?
What is the risk is using sub-custodians?

Every hedge fund should know who has the right to its assets and if there are any fees involved in the process.

In addition to custody factors, settlement, multicurrency capabilities and trade execution are also important considerations. A hedge fund should make sure a prime broker can settle in a local currency, and can also custody and report in multiple currencies. A firm will want to meet market requirements and reconcile cash, so it must first understand what its buying power is. As far as trade execution is concerned, check with the prime broker to find out if there are electronic trading capabilities and a trading desk with around-the-clock coverage.

Other factors to be aware of when selecting a prime broker are short-sale coverage, business consulting, and capital introductions. Make sure there is a stock loan desk for non U.S.-hour borrowing. Ensure that you are getting color in markets; when it comes to certain securities, there is little collateral. Certain markets won’t let firms short directly, so be aware of what your options are.

Now you know what to expect out of your prime broker. So what will your prime broker expect from you? One of the most important expectations a prime broker will have for a hedge fund will be in relation to financing. As the market evolves, different restrictions are emerging. Many prime brokers are revisiting their margin and financing agreements as liquidity issues become more prevalent. Prime brokers are giving increased liquidity which requires higher rates, additional collateral requirements, extra fees associated with margin balances held in other currencies and short rebates adjusted for international securities.