Prime custody growing in Asia, says HSBC
Prime custody witnessed substantial growth following the crisis. A study by BNY Mellon and Finadium revealed hedge fund assets in prime custody have jumped by 40% to $684 billion since 2010. However, that same survey conceded Asian managers had been slow off the mark to embrace prime custody in comparison to North American and European managers.
“The delayed interest among Asian managers in prime custody is down to a variety of factors. The domestic Asian hedge fund industry is substantially smaller than the industry in the US and Europe, and in general they were not as well prepared as their more established counterparts. Furthermore, many Asian hedge funds did not have the internal resources in place due to their size to set up a fully fledged custody or prime custody relationship. However, over the last 18 or so months, Asian hedge funds’ interest in prime custody solutions has grown,” said Chris Barrow of HSBC.
There are several other reasons for this growth. Hedge funds’ reliance on traditional prime brokers as a source of leverage has diminished since 2008, while Asian managers – much to the frustration of prime brokers in the region – tend not to use leverage that much anyway. Collateralised borrowing from prime brokers has decreased while repo-ing of fully-paid assets now accounts for the majority of hedge fund leverage. Total return swaps, contracts for difference and other leveraged products also comprise a substantial chunk of leverage.
The growing institutionalisation of Asian investors and demands by European and US investors has also prompted greater interest in prime custody in the region. “Prime custody is something that is certainly investor driven. Investors want to know where their assets are located and ensure that these assets are well protected,” added Barrow.
“We are operating in a difficult capital raising environment for hedge funds, and managers in the region feel they need to institutionalise their business in order to attract investors. One of the first things investors look at is service providers and the type of prime brokerage/prime custody relationships and solutions they have in place,” he continued.
Investor and manager concerns about counterparty risk and safekeeping of assets in light of the Lehman default, and more recently MF Global, have also facilitated the move towards prime custody in Asia. “The real catalyst for prime custody globally was the Lehman default. While a lot of managers in Europe and the US had started making preparations for such a scenario, the same cannot be said for Asia. However, this again is changing,” he said.
In terms of prime custody solutions, Barrow said the internal custodian model, and to a lesser extent the triparty model were the most popular among managers and investors in APAC. The same cannot be said for bankruptcy remote vehicles or “special purpose vehicles.”
“Special purpose vehicles are legally and practically untested. Clients are reliant on the staff at the entity who are employed on dual employment contracts. Question marks remain about whether these individuals would be around for the unwind process after a bankruptcy event . There are a lot of practical considerations which many investors and managers still express reservations about,” highlighted Barrow.