A Healthy Evolution: How market ‘stress tests’ are reshaping the hedge fund-prime broker dynamic

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‘A healthy evolution: How market ‘stress tests’ are reshaping the hedge fund-prime broker dynamic’ was published by Hedgeweek featuring Jack Seibald, Managing Director and Global Co-head of Prime Brokerage and Outsourced Trading at Cowen.

The Archegos meltdown, the “meme stock” short-selling squeeze, and new curbs on Chinese education stocks contributed to a “significant stress test” for the prime brokerage sector in 2021, one which potentially heralds far-reaching consequences for the ways prime brokers and hedge funds do business in the future.

Speaking to Hedgeweek, Jack says the three seismic events have had sizable consequences to the prime brokerage sector, and could prove pivotal in shaping the outlook for 2022.

The dramatic collapse of Bill Hwang’s Archegos Capital Management in March – which led to Credit Suisse and Nomura exiting or scaling back their prime brokerage offerings – revealed a failure of risk control procedures, with an “outrageous” amount of leverage provided to one entity with highly concentrated collateral, according to Seibald.

“That’s basic Prime Brokerage 101 – you just don’t do that,” he says. “You don’t allow outrageous leverage on concentrated portfolios – it’s the basic principle of risk management. With a standard portfolio you provide a certain amount of margin relief, and then as you delve into the portfolio, you tighten up the margin requirements based on factors like concentration, liquidity and volatility,” he says.

Jack goes on to examine risk management and risk models, the drivers for change, potential challenges on the horizon and the recipe for long term success in prime brokerage.

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