Hedge Funds Concerned Over FXPB Consolidation: Survey

The latest report by research firm Acuiti has found that consolidation amongst FX prime brokerage providers is a matter of increasing concern for hedge funds as it raises the risk of reduced access to liquidity and heightens operational risks associated with moving providers.

The report, The Rising Risk of FX Prime Brokerage Consolidation, was commissioned by Standard Chartered and is based on a survey of executives at 57 hedge funds. It finds that 39% of respondents had reduced the number of FXPB relationships in the past three years – within this, while some had made their decision to consolidate, a third were forced to do so due to the exit from the market of their existing provider.

Additionally, 24% were offboarded by a provider – something that was a feature of the market post-epidemic as banks in particular battled increasing capital and operational costs associated with running the PB business. Acuiti says hedge funds that were offboarded or saw their provider withdraw from the market reported reduced access to liquidity, the costs of onboarding and integrating with a new PB and increased operational and settlement risk as the results of a reduction in providers.

The report notes that FXPB as a business line for the sell-side has come under scrutiny over the past five years in the wake of several high-profile losses and the Archegos Capital Management collapse which, while the troubles the fund faced stemmed from equity derivatives, it caused a re-evaluation of hedge fund risk at banks. At the same time, it adds the commercial and risk profile of providing FXPB 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.

This is creating a two-tier market in which smaller hedge funds, particularly those with an asset under management (AUM) of below $1 billion, risk facing incomplete offerings with a limited number of providers, the study found. This divergence was perceptible in hedge funds’ satisfaction levels with the number of FX prime brokers available to them.

Roughly the same proportion of respondents were very satisfied, but smaller firms were significantly more likely to be unhappy with their FXPB options – 43% of firms with an AUM of less than $1 billion were either quite (30%) or very (13%) unsatisfied, compared with 12% and 8% respectively among firms with an AUM of over $5 billion.

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

Significantly, Acuiti says levels of concern were highest among hedge funds that had been offboarded or experienced a provider withdraw from the market. These firms have experienced the disruption and do not want to do so again.

The study also found that hedge funds are looking to increase FXPB providers, primarily to access unique opportunities in the international FX market. This will prove challenging if the market continues to consolidate.

“Hedge funds are highly reliant on their FXPB providers and it is no surprise that levels of concern are high across the market,” says 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.”

Andy Ross, global head, prime & financing, financing & securities services, Standard Chartered, adds, “The survey shows that hedge funds are encountering an increasing challenge in finding a prime broker for F PB and firms have no executable back up plans in the event of services being withdrawn by their core provider. At the same time, with ongoing growth in the global market place, hedge funds from across the world are looking for a partner that can provide access to a broad spectrum of currencies to optimise their trading strategies.”