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a result , it led to a rise in disputes with their clients .
“ Brokers have been inconsistent in applying some of their more complex , portfolio-based margin methodologies . These agreements typically involve sophisticated calculations that don ’ t get triggered other than in times of significant market volatility ,” says David Nable , managing director , Arcesium .
“ Perhaps because these clauses are so rarely triggered , the brokers haven ’ t tested them in practice as fully as other terms . As a result , we have seen a notable uptick in the number of margin disputes due to incorrectly applied methodologies .”
There are also concerns that once the dust settles , there is a possibility that hedge funds and other buy-side firms will make claims against banks as their positions were closed out due to delays in covering margin shortfalls .
“ Usually the client has until the end of the day to cover positions , but where assets have been rehypothecated , for the purposes of leverage and financing and effectively immobilised , accessing collateral quickly will be a challenge for some ,” says Dave Grace , managing principal , Capco .
“ Some banks would have taken prudent risk management decisions to protect themselves against any potential client default and liquidate positions . The result may be that clients sustain realised losses on their books , and some have started legal proceedings against their banks .”
At the same time , those within the risk management departments of prime brokers may begin to take a closer look at their clients and how exposed they are to those funds that saw big losses . “ Across the industry , we are seeing the credit departments of prime brokers beginning to review some clients who saw significant drops in AuM ,” says Nomura ’ s Brech .
But again , not all prime brokers experienced the same operational headache as others . Brech explains that their hedge fund clients were able to meet all of their margin calls , and JP Morgan ’ s Cossey says , “ as with any change in working conditions , there were some bumps in the road but we provided a stable financing platform and a stable framework where margin calls were met .”
Nevertheless , the ABN Amro example and the ‘ system-wide margin call ’, could force some prime brokers to revisit both their risk management and margin framework . In instances where liquidity and funding solutions dry-up , prime brokers may face questions around how to sustain longer-term financing models in a prolonged crisis , and in doing so , future-proof losses for themselves and their clients .
“ The crisis brings risk management practices and processes into the spotlight across the board . It is an opportunity for people to take a step back when they look at their models and to carry out an analysis of what worked and what needs to happen to make sure we are insulated for future shocks ,” says Credit Suisse ’ s Dlublac .
The road to recovery After the March madness – and the subsequent aftershock in early April – global markets rebounded hard in the months that followed . At the end of April , the S & P jumped 30 % from its record low , and hedge funds followed suit in rebuilding risk .
For US-based hedge funds , net leverage a measure of how much risk they are taking as they chase returns – fell during the March selloff to the lowest it has been since 2010 , but “ both gross and net ( leverage ) have bounced back ,” according to a report by Morgan Stanley ’ s prime brokerage team in April .
54 // TheTRADE // Fall 2020