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Hedge Funds Gain Access to Data on Prime Services, Swaps & Funding Costs

S3 will distribute counterparty analytics through Portware to help hedge funds and asset managers understand the costs of prime services, swaps, and custody services.

With Basel III impacting bank buy-side and sell-side trading relationships, S3 is delivering counterparty risk analytics to clients of Portware, a global provider of multi-asset trading automation.

Portware clients in North America, Europe, and Asia -- which collectively manage more than $8 trillion of assets -- now have access to S3's Blacklight, a counterparty intel analytics platform that gives asset managers access to their prime broker, swap, and custodial data.

"Banking's issues with Basel III create downstream issues for asset managers," S3 founder Bob Sloan said in a press release. "Whether you are a long-only manager or a totally liquid hedge fund, Basel II will impact how you trade. S3's Blacklight delivered through Portware will allow the buy side to assess their counterparts holistically."

Sloan tells us buy-side firms will want to know how much balance sheet they are consuming from prime brokers.

Though Basel III will not take full effect until 2018, banks will report new leverage ratios to regulators starting next year, according to a JP Morgan report issued in February. The report explains the impact of Basell III on the hedge fund-prime broker relationship, now that leverage is constrained.

Opaque prime services world
Sloan told us asset managers and hedge funds that rely on prime services and custodians for financing their positions spend a lot of time gathering data to analyze the cost of these services. "It's a very opaque market. There's no exchange. There's no venue for getting price efficiency for all the services that happen out of the prime services and equity swap world."

Today managers and funds obtain this information in an ad hoc manner by going to many portals, he says. Reports are manual, and traders create their own spreadsheets. "They spend so much time interpreting data rather than acting." Yet the prime services business is almost one-and-a-half times the size of commissions paid by institutions.

But there is no standard protocol for the prime services, equity swaps, and custody world.

S3's Prime Information Exchange (PIX) protocol "captures and standardizes all relevant prime, custody, swap, and contractual data," the company said in the release. And Blacklight "reduces the amount of time necessary to manage prime, [equity] swaps, and custodial data by three to seven hours per day."

The former head of prime services at Credit Suisse, Sloan established S3 12 years ago to bring solutions to the buy side for managing information coming out of the prime services and swaps, giving them clarity into how the business runs and costs and risks involved.

"We aggregate and normalize and optimize all the information, positions that come from a manager, and we will use our protocol so that they can standardize all the prime services, swap, and custody information in one place" Sloan told us. "We give them the algorithms, the efficiency, the total size of their wallet, the cost, and the counterparty risk that they incur."

Currently, equity swaps trade in the bilateral market, but not yet on SEFs, though they could be on SEFs in the future, he said.

That is why Portware will redistribute S3's solutions to its clients. "They understand the traders' most precious commodity is time. If you can start comparing trading costs with financing costs in a quick way, you're going to save yourself so much time, and it will allow you to be more impactful to the organization."

Portware CEO Alfred Eskandar said in the release that its clients "will benefit from Blacklight's apporach to data standardization, which together with our trading automation solutions, will allow cleints to be more informed about the trades they make every day and their true cost impact."

For the first time, Sloan said, a trader will get his or her arms around the entirety of the trade -- not just the cost or market impact, but what happens after the settlement, all the way downstream into the trading cost structure. Blacklight will help traders pull together data on stock borrow, the use of collateral, the use of cash and long positions, and other data points.

"You are starting to get a real picture of who you are paying and why and what you are getting back in terms of services and liquidity," he said. "You are seeing the full wallet -- custody, prime services, and swaps, plus the cost of execution."

Under Basel III, prime services costs for financing and leverage could go up, since banks have to set aside more capital. Hedge funds will want to know how much balance sheet they are consuming. "A $10 million customer that uses a lot of capital and balance sheet is not better than $5 million customer," Sloan said.

In its report, JP Morgan advises manager to "understand in detail the holistic value of their relationship with the prime broker's organization, considering all elements of wallet allocation -- long and short financing -- along with the non-capital/balance sheet consumptive services such as custody and fund administration as well as execution."

Beyond hedge funds and prime brokers, Sloan said, the Basell III will have implications for long-only asset managers whose assets are held at custodian banks. "They could just be doing custody, and they could just have their assets covered at an agent bank. Basel III is changing the definition of what a good customer is." Even if the customer is charged for the capital it utilizes, that doesn't mean the service provider wants that.

Part of Blacklight's value is in showing the customer how to offset these capital charges, he said. The analytics gives recommendations for how to lower those capital charges, "which the service providers will love you for. It fundamentally changes the sell side/buy side relationship."

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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