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Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
the client’s unutilized supply, there is a third option
to post, upgrade or downgrade that supply to use
as collateral. With the revenues or cost savings
associated with those collateral transactions also
accumulating to the same part of the sell-side
organization, this allows the client yet another path
to market for their supply.
The shift from a dedicated agency lending model
to a “supply optimization” approach is illustrated in
Chart 33.
With one point of contact into this new “bundle” of
services, competing incentives are removed and a
product-centric, rather than client-centric view is
created in terms of how to best utilize supply.
Optimal Use of Client’s Assets Requires
Multiple Paths to Market
With the foundation in place to think holistically about
the potential uses of a client’s supply, there starts to
be many routes to market that the solutions team in
the new organizational construct could offer, some
of which could save the client money; some of which
could make the client money and some of which
would be neutral, but eliminate operational friction.
The goal in this emerging environment would be to
come up with the options that would maximize the
re-use of the client’s assets wherever possible and
create a chain of benefits for the client when enacted
effectively. This is illustrated in Chart 34.
As shown, the solutions team starts with the neutral
proposition of holding the client’s asset in custody.
There are three paths the team could pursue from
that point to make more effective use of the asset.
In the first path, the solutions team could help the
client save money by spotting an opportunity for
them to use that asset to internalize against an open
short position in their financing book or to cover a
delivery fail. Both scenarios would involve them
matching up the asset against one of the client’s own
open obligations. Giving the solutions team access
to coverage experts in the prime brokerage and
custody organizations allows these options to be
more easily identified and enhances the teamwork
required to move assets internally across different
sets of systems.
The second path features the solution team identifying
an opportunity for the client to use their supply held
On Loan
via Agent
Unutilized Lendable
Supplies
Chart 33: Evolution from Dedicated Agency Lending Supply Optimization
Source: Citi Business Advisory Services
Dedicated Agency Lending Model
Used Toward
Collateral
On Loan
via Agent
Direct Loan
to Principle
On Loan
Synthetically
Supply Optimal Model
“ We see our mandate shifting from being a securities manager to
a collateral manager,” — Agent Lender
“ We are going to see an increase in collateral management
efficiency. Firms will need to optimize collateral for themselves
and for their clients,” — Agent Lender
“ The complexity of having collateral spread across different
segregation pools with differing regulations is making this a
tough market for lenders with an expertise in only one asset
class,” — Industry Trade Association