5Autumn 2016

Funds seek new options for holding cash Cautious funds know they need to keep cash on hand, but banks

don’t want deposits and creating a treasury function is expensive

Today’s low-return, safety-fi rst

fi nancial world impacts hedge

funds’ unencumbered cash in two

ways. Not only are there high levels

of cash because managers under-

standably don’t want to take undue risks,

but also the low interest-rate environment

is deterring bank-owned prime brokers from

hosting that cash on their balance sheets.

� is is a major problem. According to the

UK Financial Conduct Authority’s June 2015

Hedge Fund Survey, funds had an average

of 29% of NAV in unencumbered cash. � e

survey indicated there was approximately

$121.22 billion of unencumbered cash (as at

September 2014) across the $418 billion in

NAV surveyed. � e fi gure included 132 funds

managed by 52 fi rms.

■ Banks don’t want to hold cash

� e impact of new regulations stemming from

the global fi nancial crisis, such as the Liquidity

Coverage Ratio (LCR), is severely hampering

banks’ ability to fi nance their businesses from

deposits – especially with cash deposits from

institutional investors. � is is forcing many

banks to re-evaluate their product off ering.

Due to the impact of low interest rates on the

high-quality liquid assets banks are required to

hold to comply with LCRs, they regard taking

cash deposits – and in particular ‘non-oper-

ational cash’ – as a poor use of their balance

sheets. As a result, many banks are dissuading

hedge funds from placing cash with them, and

others are charging balance sheet utilisation

fees.

In our view, the problem is likely to worsen

towards the end of 2016 as banks reduce cash

on their balance sheets at the crucial year end

reporting period. To add to this, the search for

a cash alternative is further complicated ahead

of new US money market fund regulations,

due in October, that move prime funds to a

fl oating NAV while also allowing redemption

penalties and suspensions in certain instances.

� is gathering squeeze on hedge fund cash

has serious implications. Not only does it

potentially diminish fund returns but also

it adds to operational costs if staff need to

devote time to managing cash.

As prime brokers turn cash deposits away,

managers are responding in a number of

ways: by turning their cash over to custodian

banks, holding highly liquid securities such

as treasuries, buying money market funds

or a combination of these. According to EY’s

2015 Global Hedge Fund and Investor Survey,

58% of managers have resorted to custodians,

with 35% opting for each of the other options

respectively.

� is illustrates the operational burden

placed on hedge funds from the changing

prime broker landscape, as well as the

emerging need to improve management of

counterparty risk and collateral. � e largest

managers are building their own treasury

functions.

None of the options available for hedge fund

cash is ideal. Custodian banks are unwilling

to take cash on their balance sheets, so are

encouraging clients to put cash into specifi c

money market funds. � e new regulations are

resulting in large fl ows from prime funds and

short-dated treasury bills are arguably richly-

priced due to money fl owing out of money

market funds into these securities.

■ Citco Bank has capacity for deposits

At Citco Bank, we continue to have capacity

for our fund administration clients’ deposits

due to our conservative approach to balance

sheet management, which includes our

longstanding focus on primary allocation to

high-quality liquid assets.

We believe that today’s squeeze on unen-

cumbered cash will not abate until interest

rates rise signifi cantly. Until then, hedge funds

will fi nd unencumbered cash hard to deposit. ☐

Kieran Dolan, Managing Director, Citco Alternative Investor Serviceskdolan@citco.com

The squeeze on unencumbered cash will not abate until interest rates rise