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Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
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33
Today, competition between agent lenders occurs
on a fairly equal basis between custodial banks that
are part of broader organizations that also contain
a broker-dealer entity and between custodial banks
that operate on a stand-alone basis. Exposures the
broker-dealer has to specific counterparties are not
considered holistically with exposures that the agent
lending entity in the custodial bank may have to that
same set of counterparties.
This will not be the case as the new rules are
implemented. Those agent lenders at custodial banks
that are part of broader organizations with broker-
dealer entities must consider their combined set
of exposures. This could start to limit the ability of
certain agent lenders to do business with peers that
they regularly interact with today. Agent lending
obligations will be just one of many exposures
that these organizations may have to a specific
counterparty. This rule could thus favor those
custodial banks that have fewer competing obligations
to eat up their exposure limits.
“ We have been looking at our top counterparties
and think we are in a good place as it relates to the
single counterparty credit rules,” — Agent Lender
“ Counterparty credit limit rules are not as severe
in Europe as in the U.S. It is more a matter of
indemnification. If a bank has given a lot of
indemnification to its clients that bulked up risk, it
has to be accounted for by counterparty. This ends
up causing the counterparty to almost be seen as
a principal even though they are acting as agent,”
— Industry Trade Organization
“ The counterparty credit rule will cause a lot of
changes in the industry. Big lenders will have to
take their flow down to each other. Electronic
venues may emerge as a good intermediary,”
— Asset Owner—Institution
Source: Citi Business Advisory Services
Chart 25: Impact of Dodd-Frank Rule 165 (e)
Current State
Under New Credit Counterparty Rules
AL
#1
AL
#2
B/D
#1
B/D
#2
AL
#3
AL
#4
Broker-Dealers Exposure Viewed
Separately from Agent Lender
Broker-Dealer Aligned &
Non-Broker Dealer Aligned
Lenders Compete on Equal Footing
AL
#1
AL
#2
B/D
#1
B/D
#2
Combined View of Exposure Across
Organizations with Broker-Dealers & Agent Lenders
AL
#3
AL
#4
Limits on
Total Exposure
Between
Counterparties
Broker-Dealers at
Organizations with
Affiliated Custody Banks
Agent Lenders at
Custody Banks with
Affiliated Broker-Dealers
Agent Lenders at
Custody Banks without
Affiliated Broker-Dealers
25%
10%
25%
25%