Hedgeweek Comment: Sub-prime brokerage

Hedgeweek Comment: Sub-prime brokerage

The tales of woe are growing from the many hedge fund managers that were prime brokerage clients of Lehman Brothers. Estimates of the volume of fund assets frozen in the bankrupt investment bank's London-based accounts run anywhere from USD40bn to USD70bn - even after Lehman lost as much as half of its prime brokerage assets in the last week of its life. Hedge funds could find themselves waiting weeks to recover their assets from the administrator, PricewaterhouseCoopers - and many will not last that long.

Manager such as Harbinger (which has exposure to Lehman through swap transactions) and GLG, which says its total exposure is around USD95m, less than 1 per cent of its total assets, will be all right. RAB Capital has sued - so far without result - to recover USD50m. Not so smaller firms such as Chicago-based Oak Group, which has USD25m under management, most of it stuck with Lehman, and will close. MKM Longboat Capital Advisors says the issue is a factor in the closure of its USD1.5bn multistrategy fund, which is being wound down, although poor performance also contributed. Others will almost certainly follow.

Over the past few months hedge fund managers have discovered that prime brokers can pull the rug from under their feet by demanding extra collateral they don't have or unilaterally withdrawing credit facilities. Now they have found that prime brokers can represent an extreme form of counterparty risk.

But it's not entirely a one-way street. The haemorrhaging of prime brokerage assets in the final days was one more nail in Lehman's coffin, and since its collapse it's been estimated that Morgan Stanley has lost up to one-third of its hedge fund assets as managers feared it might go the same way.

It's all very well, with the benefit of hindsight, advising hedge funds not to rely on a single prime broker. Even before the crisis, many smaller funds were not in a position to negotiate acceptable relationships with a diversified group of counterparties; in the future, even when lending and leverage are back in fashion, some will struggle to find just one. Hedge funds must look forward to a future in which prime brokers will be rather fewer than a few months ago and their terms, except for a privileged handful of mega-managers, will be a lot tougher.

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