Northern Trust has added Deutsche Bank to its prime custody network. Northern Trust already has prime custody relationships with Merlin and Goldman Sachs.
HSBC, BNY Mellon, CITI, J.P. Morgan and State Street all offer varieties of prime custody services, where a hedge funds unencumbered assets are held with the custodian. The trend has grown in interest after hedge fund assets were lost or frozen after the Madoff Fraud and the collapse of Lehman Brothers.
According to Mark Schoen, head of product development at Northern Trust, the Northern Trust/Deutsche Bank prime custody network has been live for a month, and so far has a handful of clients using the service in Europe and the U.S. The same numbers also apply for the Northern Trust/Goldman Sachs prime custody network. Northern Trust is charging the same fees as a standard custody account for the service.
Schoen cites a number of trends that are causing increased interest in the creation of separate hedge fund accounts under the supervision of a custodian: The world has changed as a result of Lehman and Madoff, he says. One of the responses is that prime brokers have to hold the portfolio when it does not need financing away from their balance sheet. Another trend is separate accounts. We have hedge fund managers that are saying they do not need leverage, so they do not need to use a prime to hold the account or operate the stock. There is another trend around UCITS. In order to demonstrate supervision of the assets, we have seen some tremendous growth in the launching of UCITS funds and we are now seeing assets coming into those arrangements.
Northern Trust is the fund administrator for Morgan Stanleys UCITS platform, and according to Schoen, Q3 will see up to six hedge fund managers moving onto the platform. One fund, the MS PSAM Global Event UCITS fund, has already been launched. The fund is the first UCITS III Fund on the Morgan Stanleys FundLogic platform to be managed by an alternative manager, P.Schoenfeld Asset Management.
Northern Trusts relationship with Deutsche Bank is unique compared to standard prime custody arrangements. With Goldman Sachs, the Wall Street firm holds two accounts with Northern Trust, an operating account and a collateral account. Both are held in the name of Goldman, but remain on Northern Trusts books and balance sheet.
With Deutsche Bank, both accounts have remained on the German banks books. According to Schoen, this was down to Deutsche Banks preference stemming from complications in German Law. However, having the assets on Deutsche Banks books may boost the balance sheet at a time when regulators are paying particular attention to the financial wellbeing of European banks.
It remains to be seen whether hedge funds continue to be risk averse enough to safe-harbour assets with a custodian. In a recent article on prime custody in Global Custodian Magazine, Samuel Hocking, global head of Prime Brokerage Sales, BNP Paribas, says: “Investors are the ones that are pulling back, which is forcing hedge funds not to be so concerned about that issue [counterparty risk], at least not top of mind. We are not getting a big push at the moment from clients to say, ‘I absolutely want to segregate some of my assets into a custodian bank.'”
According to Schoen, the rules have changed. The way people look at risk is fundamentally different and if anything, this is a reversion to the world before the hedge fund boom. If you go back to the early 90s, it would be unusual to say Im going to leave my whole portfolio at an investment bank. Why did they do that? They wanted leverage, up to 10x leverage, are we going to see that again? We might be going back to much more normal levels of business and more prudent ways of safekeeping stock than we have when we had the hedge fund boom, Schoen concludes.
Giles TurnerNews Editor
Hybrid or Horror, the Global Custodian Magazine Focus on prime custody can be found here