Prime Brokerage Risk
Prime Brokerage Risk | Risks of Single Priming
Below is a short excerpt from an article I found on why hedge funds are now working with multiple prime brokers at one time. I believe this model will become even more important in 2009 and possibly become a required checkbox for investments from many institutional investors or a green light from institutional consultants.
Why It's Important: With the demise of Bear Stearns in March 2008 and the bankruptcy of Lehman Brothers this past September, hedge funds that had prime brokerage relationships with these firms were exposed to significant counterparty risk. Some hedge funds that primed with Lehman had their assets frozen as part of the European bankruptcy proceedings against Lehman, driving some to liquidate securities to meet redemption calls from investors and even forcing some out of business. "There are people who either had long assets on deposit and can't get them back or, worse, Lehman borrowed the assets and lent them out," explains Larry Tabb, founder and CEO of TABB Group.
Where the Industry Is Now: Most hedge funds with more than $250 million in assets have relationships with two to four primes, which are picked for their trading expertise in certain asset classes (e.g., FX or derivatives) or geographies, such as Europe or Asia. For smaller hedge funds, however, diversifying can be difficult because the large prime brokers have minimum-asset requirements and other constraints to weed out the smaller players. Smaller hedge funds, with $10 to $15 million in AUM, typically launch with a single prime broker that may provide trading systems, margin accounts, stock loans and clearing. source