Wall Street banks, including Morgan Stanley, are increasingly turning to complex synthetic risk transfer (SRT) deals to unlock capital and expand lending to hedge funds, as they compete for a larger slice of a booming prime brokerage market, according to a report by the Financial Times.
In one of the most notable moves, Morgan Stanley recently struck a capital relief deal with Blackstone, transferring a portion of the risk on its prime brokerage loans while retaining enough exposure to meet regulatory requirements, according to people familiar with the matter. The arrangement allows the bank to redeploy capital into – a key growth engine as hedge funds ramp up trading activity.
The use of SRTs – financial instruments that offload credit risk from a bank’s balance sheet to third-party investors – has surged since US regulators endorsed their broader use in 2023. While SRTs have traditionally been used for corporate and consumer loans, their application to margin loans is a significant shift, highlighting the growing importance of hedge fund financing.
Prime brokerage has become one of the most profitable divisions at major investment banks, but also one of the riskiest. The collapse of Archegos Capital Management in 2021 led to over $10bn in losses across firms including Morgan Stanley, Nomura, and Credit Suisse — exposing the inherent dangers of concentrated margin exposure.
Despite that, demand for financing from multi-strategy and macro hedge funds continues to soar. Banks are eager to support this growth – provided they can optimise capital usage.
However, completing SRT deals on margin loans presents unique challenges. Hedge funds’ rapid trading activity makes it difficult for banks to describe the underlying collateral in a static format, and strict confidentiality agreements prevent them from disclosing specific positions. To mitigate this, some banks have offered “white lists” of hedge funds involved in the portfolios, giving investors a high-level view of the exposure.
Still, execution remains difficult and expensive, with many banks struggling to close such transactions. Investors must place trust in the bank’s margin call mechanics and overall risk governance, often without full transparency into the hedge funds’ trading books.
