Managing Counterparty Risk More Important for Hedge Funds Now

The study suggests “One of the major drivers for heightened attention to managing counterparty risk are hedge funds’ concerns about the negative impact it could ultimately have on their firms’ operations should one of their key counterparties default on their obligations.” According to a press release, more than 50% of global hedge funds surveyed reported monitoring counterparty risk on a daily basis, and nearly 85% consider it an extremely important or very important business issue.

Two years ago only 26% of respondents considered counterparty risk important, and 22% viewed it as moderately important.

The press release said the vast majority (96%) of respondents to the recent survey also cited managing counterparty risk as the number one factor in selecting their prime broker relationships.

“The current credit crisis has elevated the importance of counterparty risk management in the eyes of many hedge fund managers. Creating a more systematic approach to counterparty risk management will go a long way in restoring market confidence and helping the hedge fund industry recapture its profitability,” said Sang Lee, managing partner at Aite Group LLC, in the announcement.

A new white paper published by Pershing LLC, a subsidiary of The Bank of New York Mellon Corporation, and Aite Group LLC, entitled "Risk and Reward: Hedge Funds Changing Views on Counterparty Relationships," highlights best practices that have been implemented by other hedge funds to help address and mitigate counterparty risk.

The firms say effectively monitoring counterparty risk will continue to be a critical component of a hedge fund's business operations, and the development of a standardized, well-documented approach to analyzing counterparty risk remains one of the top priorities for the hedge fund community.

Best practices for proactively managing counterparty risk, according to the white paper, include:

• Leveraging innovative services from prime brokers, such as a tri-party account approach;
• Conducting consistent internal portfolio and risk assessments;
• Formalizing business processes by outsourcing and installing in-house technology solutions such as portfolio management systems; and
• Implementing third-party independent valuation technology solutions and service providers supplemented with in-house valuation tools.

According to a press release, Pershing and Aite Group's study found most hedge funds currently go through manual-intensive processes to keep track of counterparty relationships. As hedge funds continue to expand their presence globally and invest in more complex instruments "reliable counterparty relationships will become even more critical, and continual innovation in terms of technology and services from leading service providers will be key to mitigating the hedge fund industry's exposure to counterparty risk," the announcement said.

The study is based on a survey conducted by Aite Group with 23 global hedge funds during the summer of 2008.

A copy of the study is available by contacting Pershing Prime Services at primeservices@pershing.com or at www.pershingprimeservices.com .