A year on from the collapse of Lehmans , we are staring at a distinctly remodelled landscape. The hedge fund sector falls at the extreme end of the scale.  Most industry commentators focused on the first iteration of the EC draft legislation for hedge funds, which met with such fierce opposition, that it is currently being amended.   However, there are other interesting developments within the hedge fund industry that are worthy of mention.  One of the most significant is the increasing institutionalisation of the hedge fund sector.

The heavy losses experienced by some hedge funds, combined with the negative publicity on the back of the Madoff scandal, has led to high net worth investors being the single largest investor group to exit the sector in the last year.  Recent estimates from US consultancy, Casey Quirk, highlight that high net worth investors have withdrawn $500bn from hedge funds in the last year.

The corollary is that hedge funds are now concentrating their efforts on building an institutional investor base.  The BNY Mellon/ Casey Quirk research estimates that currently, institutional funds comprise 43% of hedge fund investment, with this expected to rise to nearly 70% by 2013.  This trend is having a profound impact  on the operational structures of hedge funds.

Institutional investors have a much more stringent due diligence process than high net worth investors and demand much greater levels of transparency and reporting.  This approach applies not only to the front office, but to the middle and back office too.  Anecdotally, we have heard from our hedge fund clients that a robust operational infrastructure is becoming an important competitor differentiator, particularly with institutional clients.   Since the collapse of Lehman, it’s all about the mitigation of operational and counterparty risk.

The reaction of some of our hedge fund clients to recently announced initiatives has proved testament to this.  We’ve had an overwhelming response from the industry to the European central counterparty service for hedge funds, which addresses the issue of counterparty risk.

We expect this trend to continue.  As the hedge fund industry competes for institutional funds, it will be looking for ways to ensure that as much risk as possible is taken out of the post trade arena.  Efficient trade processing, and developments such as a central counterparty service are  a shortcut to that.