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Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
Organizational Alignment & Incentive Model
Determine Focus of Team
While the benefits of having this set of functions
centralized are many, the challenge of getting there
should not be understated. Asset owners looking
to insource their lending and create holistic liquidity
management must start by re-organizing their teams
and bringing together functions that previously may
have sat in different silos.
Across most survey participants, the capabilities
comprising the new liquidity management unit feature
stock loan, repo and fund level FX/cash management.
If the organization is also trading alternatives
portfolios that are using shorting and leverage, the
trade finance team is also a core part of the liquidity
management unit.
How this set of services fit together will differ. In some
organizations, the treasury team handles both firm
and fund level FX and cash management. In these
firms, the liquidity management unit was viewed as
a part of the treasury function. This is illustrated in
Model 1 in Chart 38.
In other organizations, the treasury team only
handles the firm’s cash and FX exposures. Fund
level cash and FX exposures are left to the individual
portfolio managers to address. In such cases, it is
common that the liquidity management unit will be
created separate from the treasury team and act as
an independent entity coordinating directly with the
portfolio managers. This approach is shown in Model
2 in Chart 38.
Finally, some organizations also include their
derivatives collateral management units as part
of the liquidity management team. This was less
common as many organizations still had this function
embedded within their OTC operations or general
margin organization. Those survey participants
with this arrangement indicated that they saw the
collateral aspect of OTC migrating out of those units
into the liquidity unit over time so that there could
be better strategic decisions made around the supply
posted for this obligation. This approach is shown in
Model 3 of Chart 38.
Once the proper organizational structure was in
place, individuals with a lending skill set had to be
identified and brought in to run the team. Having
in-house expertise was seen as the bridge that would
encourage portfolio managers to engage with the new
unit. Asset owners within the organization needed to
be able to discuss their cash needs, portfolio goals,
trading strategy and counterparty preferences in
order to feel comfortable engaging with the internal
liquidity management team.
The right incentive model also had to be agreed. In
some organizations, the liquidity management team
was being run as a profit center. The team would
track the P&L they generated and split the positive
return stream with the underlying asset owner. These
splits typically favored the liquidity unit, as they had
to offer “indemnification” to the asset owner just like
an external lender would provide.
Source: Citi Business Advisory Services
Chart 38: Configurations of Liquidity Management Unit
Liquidity Management Unit
Firm & Fund Level Cash &
FX Management
Repo
Liquidity Management Unit
Liquidity Management Unit
Stock Loan
Trade Financing
Stock Loan
Trade Financing
Firm Cash & FX Management
Fund Cash &
FX Management
Repo
Stock Loan
Trade Financing
Fund Cash &
FX Management
Repo
Stock Loan
Trade Financing
Derivatives Collateral Management
Firm Cash & FX Management
Treasury
Treasury
Treasury
MODEL 1
MODEL 2
MODEL 3