Prior to the 2008 financial crisis, fund managers generally were less focused on incorporating safeguards into their prime brokerage arrangements, instead relying on the perceived strength of the prime brokers themselves to protect their assets. As prime brokers such as Lehman Brothers collapsed, however, fund managers quickly realized the error of their ways. The lessons from those mistakes continue to resonate as managers now work with their legal counsel to understand the fine print in their prime brokerage agreements and to aggressively negotiate the inclusion of asset, third-party and default scenario protections. See “Federal Reserve Credit Officer Survey Identifies Trends in Prime Broker Credit Terms, Hedge Fund Leverage and Counterparty Risk
” (Apr. 26, 2012). This final article in a three-part series outlines various protections managers can incorporate into their prime brokerage agreements to monitor and preserve control of their assets, as well as limit their exposure to sub-custodian risk in foreign jurisdictions. The first article
detailed ways managers can evaluate the creditworthiness of brokers and to weigh the relative costs and benefits of the various prime brokerage arrangements available in the industry. The second article
described how managers can mitigate risk by utilizing multiple prime brokers or engaging a third-party custodian to hold their excess cash and securities. For more on prime brokerage risks, see “Barclays Predicts Increased Financing Costs for Hedge Funds Due to Regulatory Changes Affecting Prime Broker Financing
” (Oct. 18, 2012); and “Migrating Toward Multi-Prime: Did Your Manager Decrease or Increase Operational Risk?
” (Jun. 10, 2009).