Hedge funds disrupted by withdrawal of banks from FX prime brokerage market, says research

pound close up newHedge funds are facing reduced access to foreign exchange (FX) services from their prime brokers, which could limit their investment opportunities in sectors such as frontier markets, according to research.

Consolidation among sell-side providers of FX prime brokerage is partly to blame, a report by Acuiti found.

Nearly 40% of 57 firms surveyed had reduced the number of FX prime brokerage relationships over the past three year for various reasons, but for a third of them it was due to their existing provider withdrawing from the market.

The main reason, however, for the reduction in relationships was an internal decision by hedge funds to consolidate, according to Acuiti’s report, ‘The Rising Risk of FX Prime Brokerage Consolidation’, which was commissioned by Standard Chartered.

For some hedge funds, the changes mean reduced access to liquidity and also the costs of onboarding and integrating with a new prime broker. There is also increased operational and settlement risk owing to the reduction in providers. 

Acuity said that sell-side banks and dealers offering FX prime brokerage has come under scrutiny over the past five years in the wake of several high-profile losses and the Archegos Capital Management collapse.

Archegos’s troubles stemmed from equity derivatives, but also caused a re-evaluation of hedge fund risk at banks, said Acuity. 

At the same time, the commercial and risk profile of providing FX prime brokerage services to hedge funds is leading to increases in minimum monthly commissions and offboarding of smaller firms or funds that provide lower flows to their providers. 

A two-tier market is developing, with smaller hedge funds – especially those with asset under management of below $1 billion, risk facing incomplete offerings with a limited number of providers, the study found. Smaller firms were significantly more likely to be unhappy with their FX prime brokerage options.

Overall, 53% of respondents were quite concerned and 16% very concerned about the impact on their business that the withdrawal of one of their FX prime brokers would have, and over a third did not have an executable back up plan if they were offboarded by their core provider.

An additional finding was that hedge funds are looking to increase the FX prime brokerage providers, primarily to access opportunities in the international FX market. 

“Hedge funds are highly reliant on their FX PB providers and it is no surprise that levels of concern are high across the market,” said Ross Lancaster, head of research at Acuiti. “There is an opportunity for expansion among the sell-side to meet the demand from hedge funds both to access unique trading opportunities in emerging and frontier markets but also to reduce operational risk associated with the dependence on specific providers.”

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