Competition for Hedge Fund Brokerage fees leads to regulatory inquiry: an Analysis
As the hedge fund industry grew over the years, its assets grew from tens of billions of dollars few decades ago, to well over $1 trillion in 2005, the Brokerage industry has reaped a windfall in the level of brokerage fees collected from hedge fund firms. According to the Chicago based Hedge Fund Research Inc., hedge fund assets mushroomed from about $490 billion in 2000, to about $1.03 trillion in 2005.
Competition for Hedge Fund Brokerage fees leads to regulatory inquiry: an Analysis
As the hedge fund industry grew over the years, its assets grew from tens of billions of dollars few decades ago, to well over $1 trillion in 2005, the Brokerage industry has reaped a windfall in the level of brokerage fees collected from hedge fund firms. According to the Chicago based Hedge Fund Research Inc., hedge fund assets mushroomed from about $490 billion in 2000, to about $1.03 trillion in 2005.
.The Hedge fund brokerage business is dominated by Goldman Sachs, Morgan Stanley and Bear Stearns, but lately stiffer challenges have been coming from the newer arrivals to the brokerage scene such as UBS AG, Merrill Lynch, Lehman Brothers, Deutche Bank AG, and Bank of America. There is stiff competition between U.S. and European banks for lucrative business of the booming hedge fund industry, according to Reuter’s news reports. Such competition may be producing other undeserved consequences; it may be pressuring margins and also weakening credit controls, according to analysts at prime brokerage companies. Such disclosure was made at the recent Euromoney conference.
European commercial banks are setting up prime broking operations to compete with U.S. investment banks for the lucrative prime brokerage business because of the multi-billion dollar potential in fees being generate through such endeavors. There is no doubt that hedge fund business now represents a significant part of the bottom line for financial institutions”. According to Moody’s reports, hedge funds generated $7.5 billion in equity-related fees alone in 2004, and about 40 percent of the fees went to prime brokers.
The new competition for hedge fund business may be leading to higher levels of risk tolerance; some analysts are worried that some brokers may be reducing the traditional stress testing analytical approach in favor of the value at risk [VAR] models. The VAR model allows for higher standards of leverage. According to Moody’s the margins at which prime brokers lend money to hedge fund firms have shrunk to the level of between 40 and 62.5 points, such margin stood at 75 basis points over the past three years. Moody’s had earlier warned of the new risks of multiple failures for hedge funds which may result from the growing number of unregulated hedge funds which take on the same risks as hedge funds.
The battle for hedge fund brokerage fees has also led to more scrutiny and oversight questions from industry regulators. Regulators concerned that brokers may be seizing on the popularity of hedge funds to take advantage of non-professional customers. The marketing and sales of hedge funds to individual investors has been an ongoing focus of NASD. We are continuing to look at issues in this area, but cannot comment on any of the specifics.” Nevertheless it is likely that the competition for the business of hedge funds will intensify in the coming years, because of the profit potentials of such business.
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