Operational Issues Preoccupy Hedge Funds

Terry Flanagan

Hedge funds are preoccupied with operational issues, in particular post-trade processing.

“The most significant operational trend that we expect to continue to impact the hedge fund community in 2014 is the concerted push to implement post-trade automation capabilities to reduce operational risk and total costs while better positioning the firm to meet increased investor due diligence requirements and elevated regulatory demands,” said Matthew Nelson, executive director of strategy at post-trade services provider Omgeo.

The financial markets have changed quite significantly in the last few years, post-Madoff and the financial crisis.

“Fund managers have become even more focused on managing risk and being able to demonstrate that capability to investors while satisfying regulators,” Nelson said. “Automation has played a big role in this area, particularly in a multi-prime broker model, which has added complexity around managing middle and back office processes.”

Operational Due Diligence (ODD), is an increasingly important element in the decision making process of institutional investors. Investment performance without robust infrastructure is unlikely to convince investors to entrust their money to funds where doubts exist over operational systems and procedures.

“The investor due diligence process has also become much more stringent in the last few years, with investors looking farther under the operational hood than ever before,” Nelson said. “Funds need to demonstrate robust operational processes in areas like post-trade processing. Through automation of the post-trade process, funds can dramatically decrease risk of trade failures tied to manual processes and human error.”

Cor Financial’s Salerio, a post trade processing provider to hedge funds, asset managers and third-party administrator firms, has published a whitepaper examining how post-trade processing as an example of a business critical area where proving the robustness of systems and procedures can deliver significant commercial benefits.

The whitepaper also reports that there is increasing evidence that prime and executing brokers are beginning to examine the relationship between risk and reward across their customers, with particular attention to operational procedures and the quality of information provided by clients.

“AIFMD is occupying the minds of many fund managers right now,” said Ken Skehan, head of business development at Cor-FS Salerio. A general requirement of the legislation is that the information flow between all parties in the trading cycle is effective. So an example of appropriate investment in technology would be confirming trades at the earliest point in the trading cycle, to ensure all subsequent flow of information is accurate and trustworthy.”

Many hedge funds still place huge reliance on their prime brokers for what the fund managers see as their middle and back office operations. “What new industry wouldn’t be delighted that the world’s biggest banks created the concept of prime broking to provide them with access to global money markets that enabled leveraging of the fund’s assets? Is it enough now though, to give institutional investors the comfort they seek?” said Skehan.

“Some might argue that prime brokers have an opportunity to extend their services to offer Electronic Trade Confirmation to their clients and do the job themselves,” Skehan continued. “That’s certainly a perfectly feasible possibility. However, it seems to me that if you want to solve a problem permanently, treat the root cause. Which means as early in the trading cycle as possible – and with the hedge fund taking responsibility itself.”

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