New York (HedgeCo.net) – In a new opinion piece, BNY Mellon CEO of Alternative and Broker-Dealer Services Brian Ruane argues that recent industry and economic events will see custody banks continue to play a larger role providing services to hedge funds that previously were the sole domain of prime brokers.

The paper, ‘Filling the Void: Transparency and the Rise of Custodian Banks,’ was presented to more than 150 client and industry attendees at recent events in Dublin and London.  In it, Ruane writes that due to stricter regulations following the credit crisis – from Dodd-Frank to the AIFM Directive – alternative fund managers are being compelled to reevaluate the right balance between counterparty exposure and a higher degree of safety.  Ruane says this is creating distinct operating models for hedge funds in the U.S. and Europe.

Following the crash in 2008, U.S.-based hedge funds sought out custodians to safe-keep and service their unencumbered cash and securities.  Through a custodian bank, hedge funds had the assurance not only that their un-invested cash balances were 100% FDIC insured through 2012, but also that securities would be kept off the custodian’s balance sheet and assets couldn’t be rehypothecated.  Services traditionally reserved for prime brokers, such as clearing, cash and collateral management, became components of a service partnership between primes and custodians.

The second model is the evolving European interpretation of prime custody.  In Europe, hedge funds primarily use custodian banks to provide collateral management services on initial and variation margin.  But European-based hedge funds are increasingly showing interest in custody services for their unencumbered assets as well.  Driven by the need for greater asset protection and control, hedge funds inEurope are pushing prime brokers toward service models similar to those found in the U.S.

“The universe of companies providing key services to hedge funds has shifted dramatically.  Hedge funds have gained a new appreciation for counterparty risk and financial strength and started to look at another group of service providers – custodian banks,” said Ruane.  ”Alternative investment managers in the U.S. and Europe, as well as the more institutionally focused managers in Asia, are looking to custody banks as financial intermediaries who can deliver a seamless offering.”

Ruane says the two models are evolving to meet the demand for asset protection through improved transparency.  In the U.S., several prime brokers have created partnerships with custodians.  These partnerships enable prime brokers to maintain their current relationship with their hedge funds, while offering the fund the ability to hold assets with a third-party custodian.  Interest is expanding to European shores as well. (Download PDF)

New York (HedgeCo.net) – Over the past two years, Merlin has published several white papers that are designed to highlight and help managers imple- ment industry best practices, from shoring up their business model to identifying their target investors based on the development stage of their fund.

In continuing with this theme, Merlin’s latest white paper discusses the importance of business process automation within an asset management firm at all stages of development and how these organizations can measure their current processes versus investor expectations.

Managers, investors and due diligence teams all analyze and measure the business risk and process maturity of a fund. Funds must continually review both their organizational structure as well as the level of automation resident in their systems and procedures.

A hedge fund’s assets, number of strategies, the number and type of its investors, and the amount of people required to run a fund, invariably strain the original processes a fund used when it was a startup. At some point, legacy processes, lack of automation and the lack of delineated roles pose significant operational risk and often impede a fund’s ability to scale and succeed.

“Knowing when to upgrade processes and technology and when to hire additional people is a common challenge for all businesses.”

As funds grow it is imperative that their business processes have the rules, controls and a level of automation that is commensurate with the growth of the fund and the type of investor being serviced. Funds that ignore the natural progression of process maturity will do so at their peril.

About Merlin Securities

Merlin is a leading prime brokerage services and technology provider, offering integrated solutions to the alternative investment industry. The firm serves more than 500 single- and multi-primed managers, providing them with a broad suite of solutions including dynamic performance attribution analytics and reporting, seamless multi-custody services, capital development, 24-hour international trading, securities lending experts and institutional brokerage. With more than 100 employees, the firm has offices in New York, San Francisco, Boston, Chicago, San Diego and Toronto. Merlin utilizes the custodial and clearing operations of J.P. Morgan, Goldman Sachs, Northern Trust and National Bank of Canada. Merlin is a member of FINRA and SIPC. For more information, please visit www.merlinsecurities.com.