FEATURING ABN AMRO Clearing // Concept Capital // Global Prime Partners // Interactive Brokers // Linear Investments // Newedge

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WEEKHFMS P E C I A L R E P O R T

REGULATIONHow AIFMD, Emir and Basel III have shaken up the prime broker space

TECHNOLOGYSmaller prime brokers turn to technology to stay competitive

MULTI-PRIME STRATEGIESSpecialisation of brokers and counter-party fears continue to drive the multi-prime model

We don’t just tick boxes.

We don’t simply provide services.

We provide a bespoke response in a template world.

Our services are what you would expect from your Prime Broker and include:

lending and web based reporting. But how we deliver these services is what

on the needs of start up and emerging managers.

It’s why we’ve won the HFM Week Award for “Best Boutique Prime Broker“ for two years in a row.

info@globalprimepartners.com

www.GlobalPrimePartners.com

H F M W E E K . CO M 3

he prime brokerage sector is evolving rapidly due to a raft of new regulatory requirements such as AIFMD, Emir and Basel III. There have also been significant

movements from larger prime brokers as they seek to remove their smaller clients as a result of shrinking profits from these boutique funds.

Banks specifically now have to operate under stricter liquidity and capital requirements and the effects of this on their balance sheets have been significant. However, this has allowed several opportunistic brokers to fill this gap and snap up the newly available business opportunities by marketing to smaller hedge funds.

As larger brokers begin to shed clients and focus on specialising their services, larger funds have also had to develop a multi-prime approach in order to enjoy brokerage services on all their investment strategies.

In this HFMWeek Prime Broker’s Report we speak to leading industry figures to discuss these trends and analyse how this will affect the space in 2015.

We highlight the strategies boutique players are employing, such as increased automation through technology, to remain competitive and take maximum advantage of the fertile market that has been created for them.

Finally, we assess the challenges currently facing all prime brokers and the best techniques being using to navigate them.Drew NicolReport editor

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TECHNOLOGY

TECHNOLOGY AND TRANSPARENCY DRIVE GROWTHSteven Sanders, EVP marketing and product development at Interactive Brokers, speaks to HFMWeek about how Interactive Brokers uses automation to accept funds of all sizes

LEGAL

NATURE ABHORS A VACUUM OR ‘HORROR VACUI’Executive chairman of Linear Investments Jerry Lees explains to HFMWeek the impact of Basel III and AIFMD on emerging funds

REGULATION

A FORK IN THE ROAD Gildas Le Treut, global director prime clearing at ABN AMRO Clearing, speaks to HFMWeek about how recent regulatory developments are impacting prime brokers

ALTERNATIVE INVESTMENTS

LEAD, FOLLOW OR GET ALONGSIDE?Dan Rizzuto, CFA, head of capital introductions, Americas,for Newedge, discusses traditional alternative investmentsand the newer generation of liquid alternatives

FINANCIAL SERVICES

CHALLENGES MOUNTConcept Capital’s founder, Jack Seibald, talks to HFMWeek about the numerous challenges facing hedge fund managers

PRIME BROKERAGE

EXPANDING HORIZONSHFMWeek catches up with Kevin LoPrimo, of Global Prime Partners, to discuss the fi rm’s expansion in the prime broker space

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REPORT EDITOR Drew Nicol T: +44 (0) 20 7832 6659 d.nicol@pageantmedia.com HFMWEEK HEAD OF CONTENT Paul McMillan T: +44 (0) 20 7832 6622 p.mcmillan@pageantmedia.com HEAD OF PRODUCTION Claudia Honerjager SUB-EDITORS Eleanor Stanley, Luke Tuchscherer, Mary Cooch CEO Charlie Kerr GROUP COMMERCIAL MANAGER Lucy Churchill T: +44 (0) 20 7832 6615 l.churchill@hfmweek.com SENIOR PUBLISHING ACCOUNT MANAGER Tara Nolan +44 (0) 20 7832 6612, t.nolan@hfmweek.com PUBLISHING ACCOUNT MANAGERS Amy Reed T: +44 (0) 20 7832 6618 a.reed@hfmweek.com; Jack Duddy T: +44 (0) 20 7832 6613 j.duddy@hfmweek.com; Alex Roper T: +44 (0) 20 7832 6594 a.roper@hfmweek.com CONTENT SALES Tel: +44 (0) 20 7832 6511 sales@hfmweek.com CIRCULATION MANAGER Fay MuddleT: +44 (0) 20 7832 6524 f.muddle@pageantmedia.com

HFMWeek is published weekly by Pageant Media Ltd ISSN 1748-5894 Printed by The Manson Group © 2014 all rights reserved. No part of this publication may be reproduced or used without the prior permission from the publisher

4 H F M W E E K . CO M

There has been a years-long debate, with sig-nificant investment implications, regarding which is a better choice for investors and managers alike: liquid alternative invest-ments (e.g. alternative index funds, liquid beta, and so on) or participating in a hedge

fund’s full fee alternative investment strategy? Which is better? Is it alpha or beta (alpha referring generally to uncorrelated absolute return and beta referring to returns produced from factors believed to be readily accessible at low cost)? Which is cheapest? Is lowest expense ratio the correct metric for investing in alternative investments? We have been approached by many managers and investors on this theme and we believe the proper answer for many on each side is likely to be the same… do both!

For managers who trade certain liquid instruments, if you’re too late to lead and don’t want to follow, it’s best to ‘get alongside’. Therefore, many hedge fund business models could consider a lower cost version of their tra-ditional product, as well as continuing the considerable research commitment towards uncovering new forms of uncorrelated profits and absolute returns.

For investors, this means it is now possible to exploit some traditional alternative investment opportunities through generally lower priced offerings, including mutual funds and index-based investments. But, if you choose only this path, you are near certain to miss out on the un-correlated returns offered by the hedge fund industry’s full fee strategies. In this regard, whether or not someone can describe a reverse engineered version of a unique trading

method in a whitepaper, theory is much easier than prac-tice; And, if a manager’s strategy contributes to your port-folio in a manner you can’t otherwise access, then by all means pay the well-deserved premium.

SELECTED CONSIDERATIONS FOR MANAGERSStart-up costs: For a single manager mutual fund using a multiple series trust (MST) start-up costs are estimated to be approximately $50,000. For a manager to develop their own mutual fund, the cost is a multiple of this figure, while managers accessing mutual fund investors through exist-ing mutual fund platforms can spend a fraction of MST costs. Overall, as the liquid alternative investment sector matures, efficiencies will continue to develop and costs move lower across most functional areas.

One more opportunity for individual hedge fund man-agers is to participate in a multi-manager mutual fund offering, such as those currently offered by some fund of hedge fund managers or traditional mutual fund compa-nies. Participation requires the manager to adhere to the investment guidelines of the allocator, but otherwise in-cludes only limited involvement in the start-up costs and ongoing administrative and compliance responsibilities.Opportunity cost of potential revenue: This refers to the decision to proceed with some kind of reduced fee product that may cannibalise an existing full fee offering. Alternatively, a manager choosing to stay with only full fee strategies risks missing out on one of the strongest asset raising trends since 2008.

If the industry does create a sustained opportunity for

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LEAD, FOLLOW OR GET ALONGSIDE?

HFMWEEK CATCHES UP WITH DAN RIZZUTO, CFA, HEAD OF CAPITAL INTRODUCTIONS FOR NEWEDGE, AMERICAS, TO DISCUSS TRADITIONAL ALTERNATIVE INVESTMENTS AND THE NEWER GENERATION OF LIQUID ALTERNATIVESDan Rizzuto CFA,

head of capital introductions, Americas for Newedge. Newedge is a world-leading derivatives broker and is 100% owned and controlled by Societe Generale.

H F M W E E K . CO M 5

investors to access an equivalent or better product for lower cost, history tells us that market forces and rational investing will drive disintermediation in favour of the low-cost products. This is a key motivation for hedge fund managers to participate in the lower cost trend and simul-taneously strive to develop more sources of alpha.Transparency: There are specific disclosure requirements for mutual funds that hedge fund managers should con-sider. Managers who feel that too much detail provided regularly may compromise the portfolio will want to protect their existing investors and the intellectual property. That said, some products offering liquid quantitative strategies provide full formula-level transparency that describes how buy and sell signals are generated. Importantly, investors still pay meaningful fees for such products; likely because the value added goes well beyond specific trading signals and includes skilled risk management, execution, and other elements of the professional portfolio management process.

There is also the concern that more granular details broadly distributed to investors less qualified to interpret such information properly, can create confusion and other complications. Liquidity: It has always been proper policy to provide investors liquidity terms that reflect the liquidity of the underlying assets, subject to practical administrative con-siderations. Large cap listed equities, equity index and fixed income futures, and G-10 foreign exchange are all highly liquid asset classes seemingly well suited for daily liquidity structures like mutual funds. As you move further down the liquidity spectrum, the appropriateness for daily liquidity products likely decreases. Complexity of strategy replication: A number of sys-tematic ‘factor-based’ strategies have been replicated in exchange traded funds and other vehicles in the liquid al-ternative space. These are generally less complex strategies with relatively simple trading rules. Discretionary global macro and esoteric systematic strategies where signal gen-eration represents guarded intellectual property have been harder to offer in a ’40 Act format. Pursuing a scaled down version of such strategies may create considerable tracking error and too much administrative and compliance effort to justify the risk and expense of managing the product.Distribution: An effective in-house or out-sourced as-set raising capability is always of paramount importance for managers. Successfully raising and retaining diverse sources of investor capital is an extraordinarily competi-tive task and long-term commitment. Successful business development becomes even more challenging for hedge fund managers trying to reach capital across the investor spectrum as the skill set and process needed to win institu-tional mandates vary widely from those needed to succeed as a mutual fund manager. Effectively expanding into the liquid alternative universe while maintaining your tradi-tional hedge fund investor base requires a significant stra-tegic plan and economic commitment to building a more substantial distribution and client service strategy.

SELECTED CONSIDERATIONS FOR INVESTORSExplicit cost: Expense ratio has historically been a driving metric for fund selection in the mutual fund space and seems to be important as well in the liquid alternatives space. This is a very curious due diligence approach to a hedge fund in-

dustry that has been built on competing based on net of fee returns. In the traditional hedge fund space, those manag-ers that most consistently produce the highest absolute and risk-adjusted net returns, all else equal, represent the optimal investment choice, regardless of fees paid to the manager by the investors. Expense ratio ranking is clearly a departure from this perspective and likely an ineffective approach to liquid alternative investing.

For example, there is already observable, disparate performance between seemingly similar strategies in the liquid alternatives space. Simply choosing the least-cost option ignores the sources of this performance divergence and their potentially dramatic implications.Diversification: This remains a key tenet of proper port-folio construction, yet it can often be taken for granted, particularly when it is difficult to observe for extended periods of time. This had been the case with the onset of global quantitative easing and coordinated central bank activity. Though true diversification is always at work on behalf of a properly constructed portfolio, it can be most apparent during periods of significant market stress. Even so, throughout history, periods where equity markets per-form ‘normally’ for extended periods of time tend to lull investors into more concentrated investing and decreased diversification.

Liquid alternative investments have created greater ac-cessibility for individual investors across the wealth spec-trum. With the support of the private wealth advisory and registered investment advisory industries, investors have an extraordinary opportunity to take their investing and diversification to a level previously unavailable.Liquidity: Historically, greater liquidity has been pref-erable and certainly the move toward ETFs and mutual funds has introduced a meaningful amount of daily liquid-ity choices into the alternative investment space. In con-trast, recent trends in the institutional investor space have moved towards matching asset liquidity with liability de-mands in a ‘solutions-based’ approach to investing. Better matching investment accessibility with actual capital us-age is an effective way of optimising investment outcomes and suggests that always choosing the most liquid asset in every sector of your portfolio may not be as important, or beneficial, as believed.Taxes: We encourage investors to always include an after-tax perspective when investing. There are different tax implications for the various investment structures used to access alternative investments. These considerations are investor specific, investment vehicle and investment strat-egy specific as well.

CONCLUSION:There are pros and cons to both traditional alternative in-vestments and the newer generation of liquid alternatives, far more to be considered than those listed above. The op-timal solution is likely to be one of inclusion, where the investor wisely constructs a portfolio that most efficiently achieves their investment goals. In so doing, the invest-ment management community is properly incentivised to mine for the uncorrelated, positive returns offered by their alpha strategies and also to offer commensurately priced strategies representing the more standardised exposures of liquid beta products.

A LT E R N AT I V E I N V E S T M E N T S

Interactive Brokersfor Institutions

hfm

12-IB13-703

Certain financial products are not suitable for all investors. Customers should read the relevant risk warnings before investing. Your capital is at risk and your losses may exceed the value of your original investment. Interactive Brokers LLC, an affiliate of Interactive Brokers (U.K.) Limited, is regulated by the US SEC and CFTC and is a member of the SIPC (www.sipc.org) compensation scheme; products are only covered by the UK FSCS in limited circumstances.Interactive Brokers (U.K.) Limited is authorised and regulated by the Financial Conduct Authority. FCA register entry number 208159. [1] Plus exchange, regulatory, transaction and carry fees where applicable. Commissions above are for US products; inter-national products available at comparable rates. For complete details, see interactivebrokers.co.uk/commissions.[2] For additional information regarding best price execution, see interactivebrokers.co.uk/bestexecution.

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H F M W E E K . CO M 7

To someone who’s been involved in the hedge fund industry for a long time, fi rst as a man-ager and then as a service provider and inves-tor, it’s clear that the current environment is turning out to be a challenging one for emerging and even established hedge fund

managers. In addition to the typical performance and capi-tal raising pressures they face, managers are now having to deal with pushback by investors on the fees they charge, the newly imposed regulatory burdens resulting from laws passed in the aft ermath of the fi nancial crisis, and a rapidly changing prime brokerage environment largely driven by more stringent bank capital and liquidity rules.

PERFORMANCENavigating low-volatility, one directional markets has al-ways been a diffi cult task for hedge fund managers. No matt er the performance, even when it stands out against hedge fund benchmarks, it’s tough to impress investors when they’re watching the broad equity market averages make successive new highs. Th is has largely been the case since the stock market bott omed in the spring of 2009, es-pecially so during the past two years, and remains a frustra-tion for many managers in 2014. Th rough October, hedge

funds were about fl at on average as measured by the HFR broad index. Th ough certain strategies are clearly perform-ing bett er than the hedge fund indexes, those funds that have exceeded market returns remain few and far between, and fi nding them is a diffi cult chore. While it is generally understood that hedge funds aim to produce above aver-age absolute returns over a market cycle, with no meaning-ful market declines since the recent bull market started in the spring of 2009, proof of this concept has been diffi cult to produce and investors are growing more sceptical.

ASSET GROWTH Raising assets, for most emerging managers, remains a frustration as well. While capital keeps fl owing to the al-ternative investment space at a rapid pace, a very dispro-portionate share continues to reach the coff ers of only the largest and best known fi rms. In part, this stems from the posture assumed by the allocators, who tend to favour well-known established managers with longer track re-cords, and with whom other reputable institutions have invested. Th is skew is also driven by the fact that access-ing pools of capital from the large institutional allocators such as public pension funds and large endowments is a daunting task. It involves lengthy lead times, engagement

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CONCEPT CAPITAL’S FOUNDER, JACK SEIBALD, TALKS TO HFMWEEK ABOUTTHE NUMEROUS CHALLENGES FACING HEDGE FUND MANAGERS

CHALLENGES MOUNT

Jack Seibaldis a founder and managing member of Concept Capital Markets, LLC. He has been affiliated with the firm and its predecessors since 1995, and has extensive experience in prime brokerage, investment management, and research dating back to 1983.

F I N A N C I A L S E R V I C E S

8 H F M W E E K . CO M

with consultants who serve as gatekeepers to the institu-tions, and extensive due diligence processes that include not only a vetting of the manager’s investment strategy and process, but also the soundness of operational infrastruc-ture. Emerging managers are not as well suited to endure this gruelling process and seem to gravitate toward assets from other pools of capital with a demonstrated histori-cal propensity to invest with less well-known managers, including family offices, investment advisers, smaller endowments, managed account platforms, and the like. When capital does find its way to these managers, increas-ingly it’s coming through some alternative structure like a separately managed account. Such allocations typically add some operational complexity to a manager’s routine and increasingly come with lower fee structures.

FEESTalk of fee compression has been around for a while, but seems to have taken hold this year. This is likely the result of both the subpar performance of hedge funds in recent years and the increasing demands placed on managers by those willing to allocate to them. The proliferation of liquid alternatives in the retail market place is a driver of fee com-pression as well, as most such products don’t provide for performance-related fees, but rather only asset man-agement fees. One could argue that managers are not particularly helping their cause when they agree to put their strategy in a liquid alternative such as a ’40 Act mutual fund. While many see this as an avenue to po-tentially grow assets more rapidly and others make the argument that it helps to di-versify their investor base, managers should consider the risks associated with such strategies, not the least of which is losing those in-vestors in their co-mingled funds who are paying the full management and incen-tive fees. After all, if a manager’s strategy is available in a more liquid, and sometimes even transparent, structure at a lower cost to the investor, why would anyone want to pay more for a product with less frequent liquidity?

REGULATORYHedge fund managers are facing the new regulatory re-quirements imposed in the US, UK and EU on alterna-tive funds. With the rule changes, which of course are not consistent from one domicile to another, managers are required to register with regulatory agencies and file regu-larly scheduled reports on their portfolios and investment management businesses, and are having to spend time as well as money to comply with the new schemes. While those managers with large AUMs have had a taste of Form PF in the US in the past couple of years, and have had the resources, both financial and human, to deal with these

mandates, large numbers of managers, including many with far fewer resources, will in coming months come to grips with these new obligations as the rules begin to apply to them as well. Add to this the implementation of Annex IV reporting under AIFMD, which affects managers domi-ciled in Europe and those marketing to European inves-tors, at the start of the New Year, and it’s clear that man-agers will find themselves distracted. How managers deal with these increased obligations, and the distractions they will cause, will say a lot about their prospects. It should be concerning that many managers still appear to be procras-tinating and even spending precious time and resources at-tempting to figure out an appropriate way to avoid having to comply (reverse solicitation sound familiar?).

PRIME BROKERAGEJust in case the aforementioned issues weren’t enough to keep hedge fund managers on edge, the rapidly chang-ing conditions at banks and prime brokers pose another challenge. These changes are in large part driven by the implementation of Basel III, a comprehensive set of re-form measures to strengthen the regulation, supervision and risk management of the banking sector, and thereby improve its ability to absorb shocks arising from financial and economic stress. As banks work to meet the more stringent capital and liquidity requirements imposed on them, their actions are impacting economic activity and the financial markets. Readers will recall that even former Federal Reserve chairman Bernanke was recently turned down for a mortgage. For hedge fund managers the is-sues are significant. Following lengthy internal reviews at a number of the prime brokers, many have been notified that the level of revenues earned by their banks was no longer sufficient to warrant either the amount of balance sheet impact caused by the fund holdings or the expense involved in servicing the fund. In some instances manag-ers have been informed that higher fees would be required, in others that the amount of leverage offered would no longer be available, while in others that the banks were no longer in a position to hold the funds due to the capital haircuts the banks need to take on certain fund holdings. While this process started with the European-based prime brokers about a year ago, the wave washed ashore in the US earlier this year and has now reached most of the large banks, and in some cases also the mid-tier prime brokers. Many hedge fund managers are now under a year-end deadline to find new brokers. The message to managers should be clear: financing costs are likely going up, lever-age will likely be curtailed, services will be pared back (un-less paid for), and minimum monthly revenues are likely to become the norm.

THE WAVE WASHED ASHORE IN THE US EARLIER THIS YEAR AND HAS NOW REACHED MOST OF THE LARGE BANKS AND IN

SOME CASES ALSO THE MID-TIER PRIME BROKERS

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H F M W E E K . CO M 9

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HFMWeek (HFM): How has Global Prime Partners developed in the prime broker space in the last year?Kevin LoPrimo (KL): We have been in the prime brokerage space for four years and have continued to grow rapidly. As our name has become more mainstream in the market we have a lot more global clients seeking our services, in Europe and Asia. We also have interest from the US but we are not currently licensed there, so we have to focus on Europe and Asia. It has been a more fruitful environment lately because our reputation has developed and as a result larger funds are starting to approach us.

We have also enjoyed an ele-ment of being in the right place at the right time due to the regulatory changes with the banks, which has caused

them to cut back on their prime brokerage services or the number of clients they are taking on. Banks are now only

dealing with the larger clients be-cause of the high cost of their bal-ance sheet. In most cases banks are only taking on clients who are paying a minimum of $1m net revenue a year. By not being a bank, Global Prime Partners (GPP) doesn’t have this issue.

HFM: Is GPP benefi ting from this recent trend? KL: Th ere is certainly more busi-ness out there for us to target and bring on. We are expanding and are now a litt le over $1.3bn AUM. We are also expecting that to grow much more rapidly than in

our fi rst four years because we are now dealing with larger funds. A certain critical mass must be achieved before larg-

BANKS ARE NOW ONLY DEALING WITH THE LARGER

CLIENTS BECAUSE OF THE HIGH COST OF THEIR

BALANCE SHEET

”

HFMWEEK CATCHES UP WITH KEVIN LOPRIMO, OF GLOBAL PRIME PARTNERS, TO DISCUSS THE FIRM’S EXPANSION IN THE PRIME BROKER SPACE

EXPANDING HORIZONS

Kevin LoPrimo, managing director, is in charge of hedge fund services and equity finance at Global Prime Partners Ltd. With more than 28 years of experience in the brokerage industry, providing services to hedge funds throughout his career, LoPrimo spent over 19 years with Goldman Sachs.

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1 0 H F M W E E K . CO M

P R I M E B R O K E R 2 0 1 4 - 1 5

er managers become comfortable with you as a provider. The firm is six years old and our prime broker business is four years old, which is a meaningful timeframe to be in business and gives people confidence and comfort that you will have longevity.

HFM: What other emerging trends and strategies have you seen develop?KL: We are not seeing anything different from funds strat-egies. GPP focuses on strategies of listed instruments such as equities, futures, options, FX and bonds; we don’t work with OTC derivatives. We continue to see funds dealing in all those spaces and sub-segments that are dealing with global macro, equity long-short, equity market-neutral or European market neutral but we haven’t noticed any sig-nificant new trends in any of these specifically. CTAs have enjoyed an upturn in business so we are being approached by more of them that are interested in the upscale service we offer.

HFM: What challenges are you expecting to face going into 2015? KL: Traditionally, we focus on the smaller end of the mar-ket, which in Europe fall below the AIFMD minimum size requirement to register. However, as we take on larger funds it will become more of an issue to deal with their higher compliance burdens and expenses to operate and market to the European community. We must ensure we have the correct licences and services to properly provide all they need.

We are not going to rush our plans for expansion and risk developing service issues. We want to grow our busi-ness systematically and in a managed way in order to con-tinue to provide a high level of service. A reputation once lost is very tough to regain and if you grow too quickly and provide a bad service, clients will hear. We will do every-thing we can to avoid that.

HFM: GPP is looking to expand into new regions. Where are you focusing on and how are the develop-ments going?KL: With regard to Asia we already have business ongoing with managers located there through the contacts we have so far established. We plan to have a licence to establish an office in Hong Kong in Q1 of 2015. Once our team is out there we will be hiring people from the region to do the marketing and provide real time services. We are con-fident in getting our share of the market as there are very few providers in our space in Asia, similar to Europe.

In contrast, our plans to gain a footing in the US will be very different because there are similar providers to us already over there. We remain optimistic, however, because we provide a high touch service for our clients. Our team gets to know each of our clients and what their trading strategy are, how they operate with the aim of becoming a partner and extension of our client’s office here in GPP.

In addition, GPP will stand out because we come from an international arena going into the US, whereas the providers there are very US-focused. They often fall short internationally because they don’t have the right infra-structure built around multi-currency platforms. GPP is

historically multi-currency because of where and how we started, so adding functionality for US will be easy. We already facilitate trading in the US for international funds.

HFM: What new developments do you have lined up for the next few years?KL: The addition of our people in the Asian time zone will be our most significant development because at the moment we only have an electronic service to cover Asian hours here from London, with only minor staffing as needed. Once we have a base in Asia, we can provide around-the-clock service.

WITH REGARD TO ASIA WE ALREADY HAVE BUSINESS ONGOING WITH

MANAGERS LOCATED THERE THROUGH THE CONTACTS WE HAVE SO FAR ESTABLISHED. WE PLAN TO HAVE A LICENCE TO ESTABLISH AN

OFFICE IN HONG KONG IN Q1 OF 2015

”

Linear Investments Limited. Regulated by FCA. Registered in England and Wales No. 7330725. 8-10 Grosvenor Gardens, London SW1W 0DH

Linear’s Prime Brokerage offer includes financing, stock loan and custody, plus leveraged products including CFD and SWAP. Linear’s well respected regulatory umbrella structure can facilitate a fast and low overhead set-up, with low ongoing costs whilst you build track record and grow your business.

Capital IntroductionIn order to facilitate our clients and help them grow, Linear has a dedicated capital introduction team who have built up a strong network of qualified investors worldwide. We work with our hedge fund clients to provide them with an effective introduction to targeted groups of investors who have an interest in their particular strategies.Our investor base includes pension funds, institutions, family offices, fund of funds, endowments, foundations and high net worth investors. Our services include one-to-one meetings with selected investors, industry conference participation, content driven roundtable discussions, investor road shows, online portals and targeted calling.We work on a success basis, when raising funds for our clients.

Linear InvestmentsLinear is a specialist prime broker and hedge fund incubator based in London. Linear’s integrated platform solution brings together all the skills and expertise that hedge funds need in one place.

This creates an approach which will significantly reduce your operational costs and bring you to market faster and more efficiently.

We achieve this by integrating Capital Introduction, Prime Brokerage and Custody Services, Execution, DMA and Trading Desk, middle/back office operations and a Regulatory Umbrella.

Prime Brokerage, Custody & Regulatory Structure

Outsourced Trading

Capital Introduction

Regulatory Umbrella

Middle & Back Office

Prime Brokerage& Custody

DMA & Trading Desk Execution

www.linearinvestment.com

Contact:

Stephen McCreathHead of Prime Brokerage Services

smccreath@linearinvestment.comDirect: +44 (0)20 3603 6448Mobile: +44 (0)7791 765 682

1 2 H F M W E E K . CO M

HFMWeek (HFM): We have observed an exodus (forced or otherwise) of small to medium-sized hedge funds moving their money from large prime brokers to establish ties with smaller purveyors of prime broker-age services. How has this impacted your business?Steven Sanders (SS): We off er distinct advantages for smaller funds not only with our overall prime off ering, but also because we may be the only self-clearing prime broker that is happy to accept them for prime brokerage. We do not have a size minimum.

It may not be profi table for a large prime broker sup-ported by a sizable and expensive staff to accept smaller clients. However, size is not important to us because we have automated much of our operations, allowing us to of-fer all of our hedge fund clients the same level of service regardless of the amount of assets they hold with us.

One important factor in keeping a tight rein on our costs is our real time credit manager, an advanced risk manage-ment technology that works behind the scenes to man-age risk and enforce credit-related regulations. Th e credit manager eliminates the need and expense of employing a team of credit analysts, a huge cost savings to Interactive Brokers Group (IB). Th e technology also benefi ts custom-ers by providing real time account balances and margin re-quirements.

Finally, there are dozens of introducing prime brokers that can service the smaller funds. However, because they are an extra middleman in the equation, the cost of doing business with them is oft en higher. Safety of assets is also a consideration; introducing brokers may be less well capi-talised and as a result, less safe than self-clearing brokers. On a consolidated basis, IB exceeds $5bn in equity capital.

HFM: What are the advantages of going to a self-clear-ing prime broker like Interactive Brokers over larger introducing prime brokers and investment banks?SS: Introducing primes are an extra hand in the cookie jar and because of that will never be able to compete on low costs, stock lending or the business stability of self-clearing prime brokers. Every few weeks there is a new introducing prime broker being created or an existing one going out of business.

Large investment banks on the other hand oft en make money by providing a range of fi nancial services to their cli-ents and charging them for it in opaque ways. At Interactive Brokers we have unbundled our services and made them completely transparent. All of our costs, fees and fi nancing rates are available on our website and may be viewed by cus-tomers and non-customers alike. If you want global execu-tion and clearing at the lowest possible cost, we’re the place.

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TECHNOLOGY ANDTRANSPARENCYDRIVE GROWTH

STEVEN SANDERS, EVP MARKETING AND PRODUCT DEVELOPMENT AT INTERACTIVE BROKERS, SPEAKSTO HFMWEEK ABOUT HOW INTERACTIVE BROKERS USES AUTOMATION TO ACCEPT FUNDS OF ALL SIZES

Steven Sandersis a senior financial services executive with 25 years of experience leading business development, technology and marketing teams. Sanders has extensive capital markets, consumer marketing, and technology management experience.

H F M W E E K . CO M 13

OUR TECHNOLOGY ALLOWS US TO OFFER OUR CUSTOMERS ELECTRONIC

ACCESS TO TRADE ON OVER 100 EXCHANGES AND TRADING VENUES

AROUND THE WORLD

”

HFM: What changes or developments in the prime brokerage space are currently presenting the best op-portunities for hedge funds?SS: Technology and transparency. Technology is the driv-ing force behind a range of developments that are ben-efitting hedge funds. Several examples include increased automation, lower pricing and expanded global coverage. IB has automated many functions that at one time would have been very expensive to maintain. The list of opera-tions is lengthy and diverse, and includes anything from corporate actions and funding, to performance reporting and statements. Automation helps keep our overheads to a minimum, allowing us to offer our clients prime services at the lowest possible cost.

Our hedge fund clients can take advantage of these low costs and fees, which may help improve performance for their investors. Lower commissions and fees, in other words, are a by-product of our technology infrastructure that has been built out over time and aggressively updated. Our tech-nology also allows us to offer our customers electronic access to trade on over 100 exchanges and trading venues around the world, pairing that coverage with the ability to trade across asset classes and currencies from one account.

Transparency is also a key development; the internet ush-ered in an era where anyone may review blogs, social media and other sources for important information beyond a com-parison of one prime broker’s marketed offering versus an-other’s. Hedge funds seeking prime brokerage services may also rely on word of mouth recommendations or criticisms as factors in their decision-making process.

HFM: Are there any particular regions in which you’re seeing opportunities over the next year or so? SS: We have seen the most growth in our business from hedge funds located in Asia and we expect that growth to continue for the foreseeable future. We have been build-ing out our sales force in the region to accommodate the growth in business opportunities.

HFM: Is multi-prime still the way forward?SS: When funds reach a certain size it may make sense for them to have multiple prime brokers, but it’s a double-edged sword in a sense. Spreading your business around provides protection against risk and the ability to take advantage of broker-specific services. However, spread-ing your business around to multiple prime brokers also makes it more difficult to consolidate and manage all of your activity and risk. To use multiple prime brokers, you must have a solid consolidation system.

Whether the fund’s assets are in excess of $100m, $500m or $1bn, it is up to the fund manager to weigh the costs and benefits of spreading assets across multiple prime brokers. Our unique offering for funds of all sizes has attracted some hedge funds to move a portion of their assets to IB. For those funds that do bring some of their business to us, our onboarding and prime services teams are there to introduce them to our trading platform and account management system, addressing any questions and ensuring they are comfortable with the technology. Some funds eventually move a larger portion of their as-sets over to us once they see the cost savings from our low trading commissions and fees.

HFM: Have you seen any growth in demand for alter-native prime services to provide flexibility for mid-sized or newly launched hedge funds? SS: Yes, some hedge funds come to us to use our unique account structure to run their hedge fund and managed ac-counts under one umbrella. This has been a growing trend. In fact, some fund managers launching with us decide to skip the cost of hiring a hedge fund lawyer and admin-istrator altogether, choosing instead to run their hedge fund strategy through managed accounts with Interactive Brokers. Our block trading technology easily allows these managers to trade a group of accounts as if it was one larg-er pooled account.

Our hedge fund customers also take advantage of our robust global stock loan capability as well as our ability to source liquidity on hard to borrow names through our own inventory as well as through our street relationships.

HFM: What trends have you seen with the hedge funds on your prime brokerage platform? SS: Usually hedge funds that come to us are looking to keep their prime brokerage and execution costs low, keep fund assets safe in case of a ‘black swan’ event, and more recently we have noticed many funds’ top priority is capital introduc-tion. This has been particularly true of funds with less than $25m in assets; they can’t seem to get capital introduction services elsewhere. Often, funds will try us in a small way with a portion of their assets, ultimately like what we have to offer, and subsequently move additional assets.

Interactive Brokers is an automated global electronic broker that specialises in catering to financial professionals by offering state-of-the-art trading technology, superior execution capabilities, worldwide electronic access and sophisticated risk management tools at exceptionally low costs. The brokerage trading platform executes and processes trades in securities, futures and foreign exchange instruments on more than 100 electronic exchanges and trading venues around the world. As a broker, Interactive Brokers provides professional traders and investors with electronic access to stocks, options, futures, forex, bonds and mutual funds from a single IB Universal AccountSM. By employing proprietary software on a global communications network, Interactive Brokers continuously integrates its software with a growing number of exchanges and trading venues into one automatically functioning, computerised platform that requires minimal human intervention.

T E C H N O L O G Y

1 4 H F M W E E K . CO M

P R I M E B R O K E R 2 0 1 4 - 1 5

The banking crisis combined with the result-ing longer-term structural changes has put increasing pressure on banks to strengthen their balance sheets and reduce risk expo-sure. Th ese changes are now rapidly fi ltering through to the hedge fund space, the pace

forced by the impending impact of Basel III in 2015, and many hedge funds are fi nding themselves without a home. At the same time, costs and operational/regulatory burdens are escalating following the implementation of the AIFMD. Hedge funds are being squeezed from all sides.

Th is vacuum in the market creates a problem for many and an opportunity for those ready to fi ll the void. Th ere is growing demand for boutique prime brokers to con-solidate smaller and mid-sized hedge fund businesses and deliver a more palatable product back to the global prime brokers (PB) in terms of both size and structure. In addi-tion, the implementation of the European AIFMD has im-posed increasingly severe operational cost and capital bur-dens on the smaller hedge fund, which are bett er spread across a number of smaller funds within a group solution provided by a specialist PB service structure.

Basel III minimum liquidity coverage ratio (LCR) re-quirements are not scheduled to take eff ect until 2015, but banks have already started restructuring their shorter-term funding and liquidity ratios in preparation. Capital requirements were the fi rst part of the Basel III regulations to become active, increasing from 4.5% minimum tier 1 capital and 8% minimum total capital in 2013 to 6% and 8% respectively in 2015.

Additionally, structural changes are reducing the bank’s ability to internalise and off set the assets of one client to cover shorts within another. Under Basel III the off set can only be counted at 50% for LCR purposes in some cases, although there has been a soft ening of that approach in re-cent weeks. Th is will potentially radically increase the cost of fi nancing to the prime broker, inevitably leading to a cost increase for hedge fund clients. Th is in turn will force many funds to change strategies as costs escalate, under-mining the profi tability of long/short positions.

Prime brokers are now carefully inspecting their navels

THERE IS GROWING DEMAND FOR BOUTIQUE PRIME BROKERS TO

CONSOLIDATE SMALLER AND MID-SIZED HEDGE FUND BUSINESSES AND DELIVER A MORE PALATABLE PRODUCT BACK TO THE GLOBAL

PRIME BROKERS

”

EXECUTIVE CHAIRMAN OF LINEAR INVESTMENTS JERRY LEES EXPLAINS TO HFMWEEK THE IMPACT OF BASEL III AND AIFMD ON EMERGING FUNDS

NATURE ABHORS A VACUUM OR ‘HORROR VACUI’

Jerry Lees is the executive chairman of Linear Investments – prime brokerage, execution and hedge platform services including FCA incubation and Capital Introduction. He founded the electronic trading and prime broking business of CA Cheuvreux, and was the original founder of businesses at the beginning of the global cross border DMA industry, involved in FIX from the outset and founder of multiple successful technology and financial businesses.

I N V E S T M E N T S E R V I C E S

H F M W E E K . CO M 15

and looking at their capital requirements and what Basel III will mean for them in terms of balance sheet use. Cli-ent reviews are now frequently undertaken on the basis of how much balance sheet they use, how much leverage and short-selling is required versus income and resource use. It’s not just size – although smaller hedge funds will generally generate less fees (unless they are engaged in specific strategies such as high frequency trading), while at the same time requiring the same if not more resources to manage them.

This is leading to large-scale reduction in exposure to hedge funds by many global prime brokers who are discretely, and sometimes not so discretely, trying to find ways of shedding unwanted clients. We, at Linear, have had a number of hedge funds approach us in recent months with urgent requirements to find an alternative house. The Wall Street Journal reported a cull of hedge funds by large prime brokers back in August this year, Goldman Sachs Group in the US recently announced it is scaling back significantly, and a white paper published by JP Morgan confirmed that: “Structural challenges to the prime brokerage financing model are, in effect, struc-tural challenges to the hedge fund financing model.” Ac-cordingly, the report goes on to say, hedge funds should expect significant changes in their relationships with prime brokers. European prime brokers are engaged in the same process.

How and why are boutique players, such as Linear, able to fill this gap and take the place of the global players for smaller and medium sized funds? The answer, as you might expect, is not single threaded.

The solution is a combination of the lower costs base of the boutique, which enables a business such as Linear to provide high service levels competitively without the huge operational overheads of a global bank structure. In addition, the specialist prime broker is able to consoli-date the business of many smaller clients and block up the outcome to represent significant income streams for the global prime broker while only giving the larger PB one counterparty to deal with. The specialist prime broker is able to invest in IT and systems unavailable to the smaller hedge fund due to cost and scale. There are also mitigating internal offsets available to the intermediary prime bro-ker, creating room for a spread of fees between the global broker and the smaller hedge fund. And, by consolidating services such as regulatory oversight, offshore structures, compliance, risk, IT, portfolio management systems, middle and back office and capital raising across multiple clients, the boutique prime broker delivers serious econo-mies of scale.

An effective boutique prime broker must have a com-plex array of services in order to deliver value to emerging hedge funds. The burden of the new regulatory structure under AIFMD has created a massive increase in the costs and complexity of running any hedge fund and effectively creates a significant operational barrier to the success of smaller funds. Linear is increasingly being approached by smaller funds who wish to shed the operational, back and middle office, capital raising, compliance, risk, IT and even facility costs such as office space. Linear has responded by grouping together a bundle of service elements, which in-clude all of the above facets. This approach allows a smaller

fund team to streamline their operation and focus on their investment strategy.

In effect, all of the services required to support any hedge fund are now provided as a shared cost spread across many funds and in some cases bundled in as a full service offering under the prime brokerage fees. This reduces the hedge fund’s costs, greatly simplifies their model and structure and, from the point of view of any investor, the fund has a third-party ensuring adherence to regulatory and operational standards. This can resolve many issues of proof of process for smaller funds as they can point to a neutral service supplier providing a high standard of control.

Finally, raising capital for the smaller fund is a very difficult, costly and time consuming task in the current environment. They are too small to be considered by the big investors for the global PB roadshows, etc. Investors are massively risk averse and track record is fundamen-tal. Due diligence is extremely time consuming and find-ing an investor prepared to risk funds in early stage and smaller funds is like finding a needle in a haystack – not least because potential investors are secretive and cau-tious about advertising their presence. Once more, the specialist PB is able to fill this void by providing IT, mar-keting budget and specialist sales resources, which can provide a common service across multiple fund clients looking for similar investors. By grouping seeder funds, this process can be made more efficient and help the fund go through various stages of feed capital and accel-eration capital.

In summary, the pressures of Basel III and AIFMD com-bined are forcing prime brokers to shed smaller hedge funds while those funds’ operational and regulatory cost burdens are increasing greatly; a squeeze at both ends. The solution has to be through specialist firms such as Linear who can bring together effective operational solutions for hedge funds and deliver a client product to the global prime bro-kers that meets their needs for return on capital deployed. The specialist PB client, by grouping multiple funds into one, is effectively large enough and produces sufficient in-come to warrant the support cost, capital deployed to justify the business to the global prime brokers.

THE PRESSURES OF BASEL III AND AIFMD COMBINED ARE

FORCING PRIME BROKERS TO SHED SMALLER HEDGE FUNDS WHILE

THOSE FUNDS’ OPERATIONAL AND REGULATORY COST BURDENS ARE

INCREASING GREATLY

”

DESIGNED TO LET YOU FOCUS ON WHAT’S IMPORTANT

Michael S. RosenManaging Member

516.746.5723mrosen@conceptcapital.com

Jack D. SeibaldManaging Member

516.746.5718jseibald@conceptcapital.com

CONCEPT CAPITAL MARKETS, LLC

MEMBER FINRA, NFA AND SIPC

www.conceptcapital.com

GARDEN CITY, NY I NEW YORK, NY I GREENWICH, CT I PURCHASE, NY I EL SEGUNDO, CA

SANTA MONICA, CA I LOS ANGELES, CA I BOCA RATON, FL I ALPHARETTA, GA

ONE COMPLETE MULTI-PRIME

SERVICE PLATFORM

Concept Capital Markets, LLC offers a comprehensive suite of brokerage and related

services that provide traditional and alternative investment managers with solutions

that are customizable and scalable. The firm was built by former investment managers

to serve hedge fund managers, managed account platforms, institutional investors,

family offices, and registered investment advisors with turn-key solutions designed to

free its clients to focus on their core competencies. Our offering features world-class

custody and clearing options, multi asset class capabilities, leading execution and

order management systems, a seasoned execution desk, a range of financing options,

a highly professional operations and customer support team, comprehensive portfolio

reporting capabilities, and capital introduction.

H F M W E E K . CO M 17

HFMWeek (HFM): How has the new regulation im-pacted the industry?Gildas Le Treut (GT): Th e key regulatory developments that are shaping the prime brokerage, and fund manage-ment, industry today are Emir, AIFMD and CRD4 / Basel III. Th ey each aff ect the industry in diff erent ways.Firstly, Emir has aff ected the industry positively from our perspective because it has allowed us to expand our range of products into new areas such as OTC, leveraging on our clearing expertise on listed products.

Emir is compelling the buy-side to clear their OTC de-rivatives, such as interest rate swaps, which has given some

banks the opportunity to expand their services. We’ve tak-en advantage of this opportunity and were one of the fi rst banks in Europe to act as pure clearer of OTC derivatives – we continue to expand heavily in this area.

HFM: What are the links between Emir and other new areas of regulation?GT: Th ere is a clear link between Emir and Basel III, which is that the need for balance sheet is quite important: not clearing the OTC derivatives imposes a higher capital hit for the buy-side, while clearing these OTC impacts the clearer’s balance sheet. Th is also means that while you ex-

P R I M E B R O K E R 2 0 1 4 - 1 5

GILDAS LE TREUT, GLOBAL DIRECTOR, AT ABN AMRO CLEARING, SPEAKS TO HFMWEEKABOUT HOW RECENT REGULATORY DEVELOPMENTS ARE IMPACTING PRIME BROKERS

A FORK IN THE ROAD

R E G U L AT I O N

Gildas Le TreutGildas Le Treut is global director of prime clearing at ABN AMRO Clearing, a leading provider of equity and derivatives clearing services. He is globally responsible for the management and development of prime services to institutional investors and alternatives investment managers, with a specifi c focus on arbitrage strategies, relative value, equity L/S & CTA.

1 8 H F M W E E K . CO M

pand into one product, like OTC, there is anoth-er regulation that affects your initiative to expand because of the cost of capital.

In some regards the two regulations are con-flicting because as a result of Basel III some of our competitors (the prime brokers and banks in the clearing space) have been looking at their own balance sheet and have decided to withdraw from some activities.

Since 2010, a lot of banks have started, or at least announced they will start to clear clients’ OTC derivatives. However, in the last 12-18 months especially, some of them have decided to stop clearing OTC derivatives for balance sheet reasons. RBS and BNY Mellon are just two exam-ples of banks that have done this and it’s a worry-ing trend for the industry.

HFM: How does AIFMD come into this?GT: AIFMD is also shaping the industry because for the first time depository banks and prime bro-kers are working together for the benefit of their clients. They have finally understood each other’s roles and constraints; a prime broker realises the performance of the fund and the bank’s role lies in liability of asset restitution. It is new for third-parties to have to work together in terms of liabil-ity, transparency and segregation of assets.

The link AIFMD has with Basel III and CRD4 is that with AIFMD the banks have to be adamant about asset segregation and transparency if the fund is using cash securities, but, if those securities were turned into a swap or a CFD the story is quite different.

This is because depository banks have no liability for restitution if an investor uses CFDs.

However, because of Basel III and CRD4 it’s far more costly for the prime broker to have CFDs; unless they have a very large and netted hedge book. Therefore, most prime brokers are looking at their clients that are balance sheet consumers, analyse the return on equity and may ask them to leave or will significantly raise their fees.

In short, AIFMD is pushing managers towards CFDs and Basel III is putting pressure on the costs of CFDs.

This means we are now at a crossroads, with most of the regulation making prime brokers use their balance sheets more efficiently, while Basel III is actually limiting the ca-pacity of the prime brokers to use their balance sheet.

HFM: Why are some of the larger prime bro-kers removing smaller funds and becoming more specialised?GT: There is no simple answer to that. If you look at the complete value chain that makes up a prime broker it is significant and if you want to become a fully-fledged prime broker it’s a huge undertaking.

Therefore, you have to specialise, or, if you are a very large organisation, you often have a suite of different legal entities for certain products. Some of the largest investment banks have an FX prime broker within one legal entity and anoth-er, separate entity doing futures and options or

equities. You could argue that they rarely take a holistic view of their clients and the return on equity of their clients.

As such, if a client is very profitable on fu-tures and options clearing and using the same group, but a different legal entity for OTC trades, the second entity may decide to re-move some of their clients because they are not as profitable for that specific product they clear. This has happened with several banks and prime brokers.

If you want to deal with the Basel III regula-tion properly you have to look at your activity with your clients holistically. But, if they are not in the same legal entity then that’s chal-lenging.

HFM: Why is the multi-prime brokerage model attractive for alternative investors?GT: There are two ways to look at it. If you are large you are limited by your exposure to one single party. Some prime brokers are under ISDA so every position impacts the counter-party risk. Some funds have a limitation of 10% of their assets under management. Therefore, if they have $100m, they cannot have more than $10m at any one counter-party.

Alternatively, if you look at large invest-ments firms it’s not just about counter-party

risk, it also goes back to the need for specialised prime brokers.

Managers will not always find a prime broker that will cover all their strategies. If you are a traditional asset man-ager with long-only and some long-short strategies any prime broker should be able to handle that.

However, if you have a mixture of credit strategies, fixed income strategies, arbitrage, relative value and private eq-uity you need to split prime brokers. As an investment manager you will analyse which is the best prime broker that will allow the portfolio manager to materialise the best performance.

HFM: How does ABN AMRO Clearing take advantage of this?GT: Large investment managers need to have a multi-prime approach and this works pretty well. Most asset managers over $1bn have at least a backup prime broker

or two or three prime brokers. The problem comes in ensuring you give enough business to your main prime broker because it needs to look at its return in equity based on its allocation of capital under the Basel rules.

Ensuring investment managers have enough lev-erage and give enough return on equity is challeng-ing. Some brokers are struggling with that and have had to ask some smaller clients to leave.

ABN AMRO Clearing is specialised in alternative strategies, such as relative value, arbitrage, CTA, be-cause we have built our model based on cross-asset correlation. We take a holistic view of the portfolio and finance the margins as well as the cash or the short stocks, which few prime brokers do.

AIFMD IS PUSHING MANAGERS TOWARDS CFDS AND BASEL III IS PUTTING PRESSURE ON THE COSTS

OF CFDS

”

R E G U L AT I O NP R I M E B R O K E R 2 0 1 4 - 1 5

Making our clients globally competitive.

PRIME CLEARING SERVICES

Gildas Le Treut - Global Director Prime

Sales Gary John-Baptiste Europe: +44 203 192 9150

www.abnamroclearing.com

Brian Duff US: +1 312 604 8208

THIS COMMUNICATION IS FOR PROFESSIONAL CLIENTS ONLY AND IS NOT DIRECTED AT RETAIL CLIENTS.

Societe Generale is a French credit institution (bank) and an investment services provider (entitled to perform any banking activity and/or to provide any investment service under MiFID except the operation of Multilateral Trading Facilities) authorised and regulated by the French Autorité de Contrôle Prudentiel et de Résolution (“ACPR”) (the French Prudential and Resolution Control Authority) and the Autorité des Marchés Financiers («AMF»). This document is issued in the U.K. by the London Branch of Societe Generale, authorized in the U.K. by the Prudential Regulation Authority and subject to limited regulation by the Financial Conduct Authority and Prudential Regulation Authority. Details about the extent of our authorisation and regulation by the Prudential Regulation Authority, and regulation by the Financial Conduct Authority are available from us on request. 2014 Societe Generale Group and its affiliates. © David Despau – FRED & FARID

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