1. 1
organisational issues. The firm should consider
assigning leadership responsibility for each of the
three key functional areas: operations and finance,
risk management and technology. For small funds
with single strategies such as a US$100 million
equity long/short fund, a single individual such as
a Chief Operating Officer (COO) with responsibility
over all three areas might suffice. Larger funds
with multiple complex strategies such as a global-
macro fund with several billion dollars under
management, should consider separate roles for
each of the three functional areas: a COO, a Chief
Risk Officer (CRO), and a Chief Technology Officer
(CTO).
This team should report directly to the firm’s
managing partners or Chief Executive Officer (CEO).
The firm should consider creating an executive
committee which meets regularly, providing a
forum for this team to interact with the managing
partners, CEO and each other on issues facing the
firm. Once the leadership team and structure is in
place, the team should be allocated a budget and
tasked with assembling the required resources
and staff for each of the functional areas. These
measures create the organisational framework for a
robust operating platform, and highlight the firm’s
commitment to minimising operational risk.
Policies and procedures – knowing what to
do, and who does what
Developing procedures can be viewed by some as
wasteful and bureaucratic. However, it can actually
be very useful in identifying issues and solutions,
and clarifying roles. Creating written policies and
procedures also makes it easier to communicate
tasks and adjust if needed.
These should identify:
1. How to consolidate trade reporting and position
tracking across prime brokers? What are the
systems and reports to use?
2. What are the operational procedures for
settlements, cash management, handling trade
breaks and addressing failed settlements?
3. How are cash and securities reported to the
firm’s custodian?
4. What are the firm’s pricing procedures? What
products are marked using pricing models and
what are the appropriate models?
5. How are market and credit risk and limits
managed? How are these aggregated across the
prime brokers and portfolios?
6. What is the month-end accounting process? How
is the fund’s Net Asset Value (NAV) calculated?
risk management framework at the firm. The
due diligence questionnaires of institutional
investors such as funds of hedge funds, university
endowments and pension plans, emphasise fund’s
operations and risk management functions.
Increasingly, a firm’s operating platform, in
addition to performance and track record, has
become a key distinguishing feature between
hedge fund managers, and a crucial one for
institutional investors when making asset
allocation decisions. A strong operating platform
is a significant advantage in competing for
investment money and for increasing assets-under-
management.
The challenges faced when making the transition
to multiple prime brokers is a result of the
responsibility of the hedge fund’s operations,
pricing, risk and technology functions shifting from
the single ‘full service’ prime broker to the hedge
fund manager.
Often the hedge fund manager is ill equipped to
manage these functions, and has to address the
following issues:
• Organisational issues – leadership and
responsibility
• Policies and procedures – knowing what to do,
and who does what
• Coordination and timing – identifying when
things get done
• Information technology – creating a platform to
handle it all
• Complexity and reporting – aggregation and
consolidation
Let us review them one by one.
Organisational issues – leadership and
responsibility
When moving from a single full service prime
broker, the firm should first address important
The recent events at Bear Stearns and its
subsequent takeover by JP Morgan have hedge
fund managers asking very difficult questions
about their prime brokers. What happens if our
prime broker ceases to conduct business as usual?
How would we execute trades and manage daily
operations? Will we have access to our cash,
securities, and liquidity lines? Not surprisingly, the
answers are complex and often contradictory.
One response by hedge fund managers has been
to set up multiple prime brokerage relationships,
which have the benefit of diversifying the risk away
from a single broker. Hedge fund managers can
then move trade execution, securities, and cash
between prime brokers, lessening their exposure
to prime brokers that may face credit or liquidity
issues in the future. This allows for a great deal of
flexibility in the hedge fund’s operations, and helps
manage counterparty exposure and operational risk
to a prime broker.
Currently, several hedge fund managers, especially
smaller firms, rely heavily on a single ‘full service’
prime broker for most of their needs. These funds
will find it challenging to make the transition
to multiple prime brokers, as they will have to
‘in-source’ key operational, risk, and technology
functions, and rethink roles and responsibilities
within their organisations.
While making the shift to multiple prime brokers
requires a significant investment in time, effort
and money, the pay off can be significant as well.
Besides the obvious risk-mitigation benefit of
diversification, there are several other benefits such
as the ability to pick and choose between prime
brokers based upon their product expertise, quality
of execution, technology platform and service level.
Perhaps most importantly, successfully making
the transition to multiple prime brokers results
in creating a robust operating environment and
Prime Broking: Single vs Multiple?
Switching to multiple brokers will result in pay-offs
SANJAY BHARWANI, RISK ADVISORS & DANIEL CHAIT, LAB49
Table 1. Points to consider when shifting from single to multiple prime brokers Source: Lab49
Organisational Issues
Policies and Procedures
Coordination and Timing
Information Technology
Complexity and Reporting
• Create an executive committee
• Consider hiring Chief Risk and Technology Officers
• Clearly document roles and responsibilities
• Create a transition plan
• Reconcile reports before and after
• Allow time to hire and train staff
• Buy/build consolidated reporting, trading, and portfolio management systems
• Aggregate VAR reporting and other complexities
Consideration Key points
July/August 2008

2. 22
Each one of these questions should be addressed
by a written procedure and, if applicable, a formal
policy.
Coordination and timing – identifying when
things get done
Having created the organisation and policies, we
recommend that hedge fund managers carefully
plan the switch from single to multi-prime
brokerage. There can be many organisational,
technical and business challenges involved, which
can cause problems if not handled properly.
For example, setting up adequate trading
infrastructure may take many months, involving
such complexities as negotiating exchange
agreements, creating new software, expanding
facilities and providing disaster recovery (DR)
facilities. Funds may also face issues related to
historical reporting and, therefore, must ensure
that their numbers can be reconciled effectively
across the entire time period covering before,
during and after the transition. Personnel and
training needs will also have to be met during this
transition, including hiring and instructing staff
on new procedures. We suggest that a fund assign
someone to draft this transition plan and manage
the process.
IT – creating a platform to handle it all
When moving from a single prime broker to
multiple prime brokers, firms are likely to require a
significant upgrade in their information technology
(IT). For one, the brokers are likely to provide
incompatible reports, requiring funds to engineer
systems to produce unified reports. This may
include different formats (.CSV vs XML vs Excel, for
example) as well as structures and organisations
of the reporting data (for instance, different
instrument identifiers, curve definitions, term
structure definitions and the like).
Also, the fundamental systems involved in the
trading lifecycle, such as market data subscription,
analytics and order management systems (OMS),
will typically need to be brought in-house and
connected to broker systems. When using a
single prime broker, funds can often get by with
Bloomberg terminals or the equivalent. However,
when a fund outgrows this stage, or when it
moves to multiple prime brokers, it will need
to bring in one or more market data feeds to
populate their newly required pricing, risk, P&L
and other systems. This can often be a difficult
and complex IT challenge, involving negotiations
with exchanges, physical infrastructure setup and
coordination amongst various data aggregators.
Moreover, even assuming the brokers’ OMS’s
use the FIX standard, they will almost certainly
differ in details such as version, custom fields and
features supported. And of course, the question of
which instruments to trade through which broker
will have ramifications to the IT department.
Third, they will no longer be able to rely on
their prime broker’s system and a handful of
spreadsheets to handle all of their portfolio
management. Rather, the fund will need to look
at building and/or buying a variety of systems
to tackle the various aspects, including position
keeping, pricing and risk analysis.
Other complications include the creation and
maintenance of a security master, compatible
pricing models, risk calculation methodologies and
accounting and back-office logistics.
Upgrading the firm’s IT, while certainly
challenging, is also an opportunity to increase
competitiveness through superior IT capabilities.
For example, rather than trading each asset
class through a given broker, a fund could build
smart systems that can analyse the market and
intelligently manage the order flow to optimise for
lower transaction costs, faster execution times, or
better prices.
Complexity and reporting – aggregation and
consolidation.
Finally, attention should be paid to aggregation
and reporting across prime brokers and portfolios.
Some exposure information and other metrics are
often not additive and a simple sum across prime
brokers is not sufficient. A good example is Value
at Risk (VAR) reporting.
For example, assume a simple scenario where a
fund trades only equities and hedges its equity
exposure with index futures. It uses Prime Broker
A for all of its equities and Prime Broker B for all
of its index futures. In order to report VAR on the
portfolio, the fund has to aggregate the portfolio
across reports from Prime Broker A and Prime
Broker B, but could not simply add VAR reported
from Prime Broker A to VAR from Prime Broker
B. Instead, after consolidating the portfolio, the
fund has to factor in the correlations between the
equities and the index futures, and then calculate
VAR on the entire portfolio. This requires thought,
planning and tools.
Summary
Moving from a single full-service prime broker
to multiple prime brokers is difficult. However, it
has several benefits for the hedge fund manager
willing to take on the additional responsibility.
Significantly, it reduces the dependence on a
single broker that might unintentionally cause a
business disruption at the fund (operational risk)
and reduces the firm’s counterparty exposure to
that broker.
Further, it allows the fund to choose the best
provider for a given service (reporting, issue
resolution, and trade execution), by product
(equities, FX, interest rate derivatives etc.) and
not to be locked into a single prime broker. Lastly,
with the increased focus by institutional investors
on operational risk, it has the added benefit of
creating an operating platform that would easily
pass muster through the most rigorous of due
diligence processes.
In sum, moving to multiple prime brokers, while
challenging, results in an operating platform that
allows the hedge fund manager to scale their
business and address operational risk concerned
with institutional investors, convince investors
to increase their allocation to the fund and the
result is an increase in assets under management
and additional revenue for the hedge fund
management company. THFJ
SANJAY BHARWANI
Sanjay Bharwani is the founder and CEO of Risk
Advisors Inc, a consultancy that develops risk
management and pricing frameworks for hedge
funds and financial institutions.
DANIEL CHAIT
Daniel Chait is Founder and Managing Director of
Lab49 which specialises in low-latency and
distributed systems within capital markets.
Biography
Risk Advisors Inc
Risk Advisors Inc (www.riskadvisorsinc.com) is a
consultancy that assists hedge funds develop risk
management frameworks and pricing capabilities to
manage market risk, credit risk, operational risk, and
accurately mark-to-market positions. It manages and
hedges risk for complex portfolios, independent
valuation and model creation for derivatives and
other hard-to-value securities, and trading process
and systems development.
Lab49, Inc
Lab49 is a technology consulting firm that builds
advanced solutions for the financial services
industry. Founded in 2002, Lab49 (www.lab49.com)
has offices in New York and London.
About
July/August 2008