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News release
For immediate release
Caroline DUPUY
EY Luxembourg
Tel.: + 352 42 124 7552
Caroline.dupuy@lu.ey.com
Hedge funds confront impact of financial market regulations and
challenges of evolving prime broker relationships
Luxembourg, 7 December 2015 – Hedge fund managers are experiencing the ripple effects of new
regulations on banks and prime brokers, with hedge funds facing increased trading fees and broader
changes to business relationships. These dynamics place additional pressure on margins and are
leading managers to seek new growth strategies, according to The evolving dynamics of the hedge fund
industry, EY’s 2015 Global Hedge Fund and Investor Survey.
Regulations such as Basel III, AIFMD and Dodd-Frank have caused banks and their prime brokerage
businesses to focus more closely on liquidity, balance sheet capacity and funding, resulting in changing
economics for fund managers who finance trades through prime brokers. Twenty-nine percent of
respondents said their prime brokers increased fees in the past year, and an additional 22% expect an
increase in fees within the next year.
Fund managers using strategies such as distressed credit, fixed income and global macro, which can be
balance-sheet intensive from the prime brokers’ perspective, have been among those who have
experienced price increases the most. Respondents now expect price increases and broker limitations to
change the way they trade, including moving toward swap-based trade execution and reducing repo
financing and overall leverage.
Michael Ferguson, EMEIA Regulated Funds Practice and Luxembourg Wealth & Asset Management
Leader at EY Luxembourg, says:
“These dynamics are the newest challenge to an industry that continues to grapple with margin
compression, heightened competition for asset growth and ongoing requirements for technology
investments. All forms of financing are becoming more expensive for a majority of managers, and these
costs have a direct effect on overall trade economics. Investors will be indirectly affected by the
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2015 Global Hedge funds & investor survey
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increasing costs and will need to rely on communications from the manager to understand the full effect
on the fund’s performance.”
Hedge funds expand their prime broker relationships
Regulatory changes have altered the traditional business relationship between prime brokers and hedge
fund managers. Prime brokers have suggested that hedge fund managers concentrate more business
with them, though 60% of managers affected by repricing have in fact added more prime broker
relationships. Only 12% of respondents who have experienced repricing reduced their prime broker
relationships.
Many prime brokers are becoming reluctant to hold cash for hedge funds because of how such balances
are classified toward banks’ capital reserves under new regulations. Fifty-eight percent of hedge fund
managers have moved cash to custodians as a result, while 35% have purchased highly liquid securities
as cash alternatives.
Michael Ferguson says: “Many hedge fund managers are larger and more complex, with increased
financing needs. As many prime brokers have less capacity to offer than in the past, hedge fund
managers are increasing the number of relationships they have to reduce counterparty capacity risk. We
are also seeing the need for hedge funds to dedicate individuals to manage counterparty risk, collateral
and treasury functions as a result of these shifting industry dynamics.”
Managers seek financing from non-traditional sources
Hedge fund managers are beginning to explore non-traditional financing sources outside of prime
brokers. Thirteen percent of respondents are seeking or plan to seek financing from non-traditional
sources in the next two years, from sources including institutional investors and sovereign wealth funds,
custodians, or other hedge funds.
Asset growth remains top strategic priority
Achieving asset growth to counteract margin pressure is the top strategic priority for 57% of managers
surveyed. New growth methods include adding new hedge fund strategies, identifying new investor
bases and increasing penetration with existing investors.
New product launches, which was the top method for achieving growth in last year’s survey, has
dropped to less than 20% this year. New products have presented opportunities for managers, but they
also have come with challenges, as 24% of managers reported that new products had a negative impact
on operating margins.
Michael Ferguson says: “As the hedge fund business has evolved, increased competition, as well as
heightened demands from investors and regulators alike, has compressed margins via the two-fold
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squeeze of lower top-line revenues and larger expenses. Growing assets to critical mass within a shorter
timeline is critical for managers looking to run profitable organizations. Liquid alternative asset products
using the UCITS Platform in domiciles such as Luxembourg continues to be a key focus of Hedge Fund
Managers over the last number of years.
Impact of the AIFMD and the Luxembourg RAIF
The impact of the AIFMD continues to be monitored with a growing view that if Europe is viewed as an
important distribution target market, then it’s a necessary to create European product in domiciles such
as Luxembourg for this distribution. There is also a growing view that it’s not feasible to build a long-term
sustainable EU distribution strategy around reverse solicitation and/or use of national private placement
regimes. Those that don’t wish to embrace the AIFMD are alternatively turning to liquid alternative asset
products using the Luxembourg UCITS Platform. The cost and time of AIFMD compliance continues to
be a discussion point, this should be significantly alleviated with the introduction of Luxembourg`s new
investment fund structure – the Reserved Alternative Investment Fund (the “RAIF”). The RAIF which is
expected to be implemented in the first quarter of 2016, is an extremely flexible investment fund
structure must be managed by an authorized AIFM and will qualify for the AIFMD Passport. The time to
market for the launch of the RAIF will rest solely with Governance Body and its Service Providers of the
RAIF (i.e. Board of Directors, Lawyers etc),as the Luxembourg regulator will not be involved in its
creation or supervision.
Technology investments are critical for transformational change
Respondents plan to allocate 12.4% of their overall expense budgets to major technology expenditures
over the next three to five years, similar to the amount budgeted over the past two years, as managers
aim to develop robust infrastructures capable of supporting larger and more complex hedge funds.
Seventy percent of managers expect to make major technology investments in the next two years,
including investment management and trading operations, enterprise infrastructure, and risk
management systems.
Michael Ferguson says: “Today’s technology environment and the effect it has on the business is
rapidly evolving. Managers are investing to develop tools that allow for more seamless front- to backoffice data transmission, timelier and customized reporting to various constituents, and to deal with
ongoing concerns over cybersecurity. The importance of being strategic with these investments has
never been more critical.”
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