The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Counterparty Risk

  • From Vol. 7 No.44 (Nov. 20, 2014)

    Eighteen Major Banks Agree to Adopt FSB/ISDA Resolution Stay Protocol that Postpones Exercise of Right to Terminate Derivatives on Bank Counterparty Failure

    Normally, the bankruptcy of a party to a derivative contract gives the counterparty the right to terminate the contract or exercise certain rights with regard to collateral.  In an effort to reduce systemic risk upon failure of a systemically-important bank or other financial institution, the Financial Stability Board (FSB), in conjunction with the International Swaps and Derivatives Association, Inc. (ISDA), recently announced that 18 major banks have agreed to adopt a protocol that amends the ISDA Master Agreement to suspend early termination rights for two days upon the insolvency of a counterparty.  In theory, this two-day window will allow the distressed counterparty to deal with its derivatives book in an orderly fashion.  Many of those 18 banks (or subsidiaries) serve as prime brokers for private funds; the protocol could put those funds at a disadvantage if their prime broker were to fail.  See “Prime Brokerage Arrangements from the Hedge Fund Manager Perspective: Financing Structures; Trends in Services; Counterparty Risk; and Negotiating Agreements,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).  Not surprisingly, hedge funds and other interested trade organizations are pushing back, arguing that the protocol falls short on both substantive and procedural grounds.  In a letter to the FSB, a consortium of buy-side and other trade organizations have argued that the protocol will not work in practice and that it constitutes an improper end run on the legislative process.  This article summarizes the new protocol, the rationale behind its adoption, the buy-side pushback, and insights from Anne E. Beaumont, a partner in Friedman Kaplan Seiler & Adelman LLP, who believes that the protocol may not work as intended.

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  • From Vol. 7 No.2 (Jan. 16, 2014)

    Aksia’s 2014 Hedge Fund Manager Survey Reveals Manager Perspectives on Economic Conditions, Derivatives Trading, Counterparty Risk, Financing Trends, Capital Raising, Performance, Transparency and Fees

    Aksia LLC (Aksia), a specialist hedge fund research and portfolio advisory firm, recently released the results of its 2014 Hedge Fund Manager Survey (Survey).  This third annual survey solicited hedge fund managers’ views on topics in three principal areas: The state of the economy and the broader market; the state of the hedge fund industry (particularly with respect to counterparty risk and central clearing, fund financing and capital raising); and hedge fund investor concerns with regard to performance, transparency and fees.  The Survey also drew insights on trends by comparing this year’s responses to those from Aksia’s first two surveys.  See “Aksia Survey Reveals Hedge Fund Managers’ Perspectives on AUM Composition, Fees, Liquidity, Advertising Practices, Transparency, Reporting and High-Frequency Trading,” The Hedge Fund Law Report, Vol. 6, No. 3 (Jan. 17, 2013); and “Aksia’s 2012 Hedge Fund Manager Survey Reveals Managers’ 2012 Predictions Regarding Tail Risk Hedges, Portfolio Transparency, Movement of Balances Away from Counterparties and More,” The Hedge Fund Law Report, Vol. 5, No. 2 (Jan. 12, 2012).

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  • From Vol. 5 No.38 (Oct. 4, 2012)

    Finadium White Paper Highlights Potential for Growth in Prime Custody Services for Hedge Funds

    Finadium LLC (Finadium), in conjunction with BNY Mellon, has released a white paper highlighting the potential for growth in the use of prime custody services by hedge funds (White Paper).  Since the 2008 financial crisis, hedge funds have used less leverage, which has led to increased demand for custodial services for holding unencumbered assets.  On recent trends in the use of leverage by hedge funds, see “Federal Reserve Credit Officer Survey Identifies Trends in Prime Broker Credit Terms, Hedge Fund Leverage and Counterparty Risk,” The Hedge Fund Law Report, Vol. 5, No. 17 (Apr. 26, 2012).  Finadium estimates that $684 billion in fund assets may be available for prime custody services.  Prime custody arrangements offer funds potential cost savings and protection from the risk of the bankruptcy of a prime broker or other counterparty.  This article summarizes the key findings from the White Paper.  See also “Hedge Funds Turning to Prime Brokerage Trust Affiliates For Added Protection Against Prime Broker Insolvencies,” The Hedge Fund Law Report, Vol. 2, No. 25 (Jun. 24, 2009).

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  • From Vol. 5 No.17 (Apr. 26, 2012)

    Federal Reserve Credit Officer Survey Identifies Trends in Prime Broker Credit Terms, Hedge Fund Leverage and Counterparty Risk

    One of the fundamental premises of the Dodd-Frank Act is that leverage in the financial system – if inadequately monitored, insufficiently understood and too voluminous – can create systemic risk.  Accordingly, many of the provisions in the Dodd-Frank Act are intended to reduce leverage or increase monitoring of leverage.  In the same vein, regulators have been collecting information about leverage via interaction with market participants.  In the U.K., for example, the FSA conducts a periodic study of potential systemic risk engendered by hedge funds.  See “U.K.’s FSA Issues Latest Biannual Report Assessing Possible Sources of Systemic Risk from Hedge Funds,” The Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).  In the U.S., since 2010, the Federal Reserve has been conducting a quarterly Senior Credit Officer Opinion Survey on Dealer Financing Terms.  The survey generally asks dealers about the availability and terms of credit, securities financing and over-the counter (OTC) derivatives markets.  On March 29, 2012, the Federal Reserve published the results of its most recent survey (Survey).  The Survey polled the senior credit officers of the twenty largest dealers in dollar-denominated securities financing and the most active intermediaries in OTC derivatives markets.  The purposes of the Survey were to: (1) obtain a consolidated perspective on changes in the management of credit risk between December 2011 and February 2012; and (2) identify trends in financing terms between dealers (including prime brokers and other counterparties with whom hedge fund managers effect trades) and their customers (including hedge funds).  This article summarizes the Survey’s findings with respect to trends in: credit terms offered by dealer-respondents, including prime brokers; demands by hedge funds for better credit terms from prime brokers; overall use of leverage by hedge funds; credit terms with respect to OTC derivatives; and demand for and credit terms relating to securities financing.

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  • From Vol. 4 No.3 (Jan. 21, 2011)

    2010 Greenwich Associates Global Custodian Prime Brokerage Study Discusses Counterparty Risk Concerns, Sources of Assets, Balance Spreading, Leverage Levels, Separately Managed Accounts and Hedge Fund Staffing Benchmarks

    In the 2010 Greenwich Associates Global Custodian Prime Brokerage Study, institutional financial services consulting and research firm Greenwich Associates offered insight on the relationship between hedge funds and prime brokers, high water marks, counterparty risk concerns among hedge fund managers, hedge fund money raising, spreading of hedge fund cash and non-cash balances, use by hedge funds of leverage and separately managed accounts and hedge fund manager staffing.  The insights in the study were based on interviews with over 1,800 hedge fund managers across North America, Europe and Asia-Pacific.  This article summarizes the key findings of the study.

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  • From Vol. 2 No.4 (Jan. 28, 2009)

    Report by Pershing LLC and Aite Group LLC Finds Counterparty Risk Remains a Paramount Concern Among Hedge Fund Managers

    According to a white paper published by Pershing LLC, a subsidiary of Bank of New York Mellon Corporation, and Aite Group LLC, an independent research and advisory firm focused on business, technology and regulatory issues and their impact on the financial services industry, managing counterparty risk is a far more critical component of a hedge fund’s overall business operations today than it has been in previous years.  We discuss the findings of the white paper, and detail the paper’s recommendations regarding best practices for proactively managing counterparty risk.

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  • From Vol. 1 No.20 (Sep. 4, 2008)

    Hedge Funds See Counterparty Risk as a Threat to Global Markets, Expect Another Major Bank Failure

    Counterparty risk from credit default swaps (CDS) represents a serious threat to global financial markets, at least in the opinion of 75% of respondents participating in a recent survey conducted by Greenwich Associates, the financial market research and analysis firm. The survey also showed that US respondents were more concerned about the use of CDS, with 85% saying they are a serious threat to global markets. European institutions were slightly more sanguine, with roughly 55% seeing CDS counterparty risk as a significant threat. Moreover, the study also found that following the near collapse of Bear Stearns and its subsequent buyout by JPMorgan Chase & Co., almost 60% of respondents thought another large financial services firm would collapse within the next six months, while 15% believed such a failure would occur within the next 12 months. Only 27% of institutions surveyed think there will not be another Bear Stearns-type collapse. The Hedge Fund Law Report talked to the authors of the survey about their findings, and interviewed leading lawyers about the implications of the survey’s findings for hedge funds.

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  • From Vol. 1 No.20 (Sep. 4, 2008)

    Counterparty Risk Management Policy Group III Issues Report on Containing Systemic Risk

    In what some are calling a remarkable confession, a panel of prestigious Wall Street executives has issued a report acknowledging the role of the investment banking and brokerage industries in the financial shocks of 2007-2008 and calling for extensive changes in how their businesses operate. The report also contains a notable discussion of hedge funds as an “emerging issue.” The report contains 60 proposals, notably including: requiring banks to account for more assets on their balance sheets; enhancing disclosure requirements and sales standards for complex debt instruments; matching trades on the same day; and increasing risk management and liquidity standards. The report notes that “indirect” supervision of hedge funds via direct regulation of supervised entities that act as investors, creditors and counterparties to hedge funds has worked reasonably well during the past year of financial market turmoil. However, the report also acknowledges that some hedge funds (and private equity funds) contributed to the reach and severity of the recent financial crisis, thus reviving the question of whether direct supervision of hedge funds would be appropriate.

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  • From Vol. 1 No.10 (May 6, 2008)

    Australian Court Holds that Lender to Broker-Dealer, not the Broker-Dealer’s Client, Owns Securities Transferred by the Client to the Broker-Dealer Under a Securities Loan Agreement, and Pledged by the Broker-Dealer to the Lender

    • Australian court holds that under a securities lending agreement based on form developed by the International Securities Lending Association, title to securities and cash exchanged in a securities “loan” is transferred.
    • Accordingly, a broker-dealer who received shares under such a securities lending agreement acquired title to the shares, and became entitled to pledge the shares to its lenders; lenders, in turn, had right to foreclose on shares.
    • Emphasizes the importance to hedge funds of fully understanding their complex legal and collateral relationships with prime brokers.
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