Prime broker shortcomings contribute to hedge fund risk

Hedge Funds are incurring extra operational risk as a result of inadequate prime brokerage services, according to TCA Consulting.

The London-based technology consulting firm said the lack of properly integrated systems between hedge funds and prime brokers was the key operational risk concern, following a survey of 24 hedge funds and four prime brokers.

Its research found that brokers were working with poorly integrated systems and a limited degree of straight-through processing (STP). This lack of integration was hindering brokers' ability to provide information for hedge funds’ risk management processes. Hedge funds depend on their prime brokers to facilitate settlements and process corporate actions, both of which carry high levels of operational risk.

TCA's report stated that less than 50% of hedge funds relied on prime brokers to provide even basic risk measurement information. As hedge funds often use more than one prime broker, they have difficulties integrating risk reports from multiple sources and systems. Prime brokers also complicate the process, as some of the risk management tools they offer are not relevant to all their fund clients.

The report relates an example of an unnamed hedge fund manager complaining that the database used to underpin the risk measurement tools being used by its prime brokers covered only British and American shares, making it useless for emerging market stocks or non-equity instruments. Since high-quality risk assessment in these areas is crucial, such anomalies should be addressed, said Sandra Williams, author of the report.TCA declined to reveal the names of the institutions it had surveyed.