Prolonged market volatility has renewed the focus on margin costs across the industry. At times when market factors lead to sudden deleveraging and reallocation of risk; we explore 4 ways buy-side firms can address their margin strategies.

How do Prime Brokers manage market volatility?

In times of market uncertainty, risk functions at Prime Brokers (PBs) manage their client risk exposures more dynamically. Their role is to ensure enough margin is charged and collateral is held in a variety of “risk-off” scenarios across the spectrum of hedge fund trading strategies.

PB margin frameworks utilise parametrised rules and market stress shocks meant to provide stable-margin for clients whilst also covering their lending risk in adverse scenarios. These models, at times, may be outdated for the adverse market conditions they were developed for, or may not account for extreme tail risk. As such, in times of turmoil, PBs will alter the parameters for client margin agreements or house stress policies to cover any potential gaps in margin charged.

The practice of benchmarking the frameworks used to margin a PB’s clients to the PB’s own internal stress models is commonplace across all major banks. This means that dynamically changing margin parameters to ensure the margin charged stays within the stressed risk or backtesting metrics become more frequent in choppy markets.

These margin methodologies are often opaque to the end client when initially implemented as they are defined in complex model documentation. This, coupled with parameter and threshold changes that become more frequent during volatile markets, makes it challenging for hedge funds to have full transparency over their margin calculations on a daily basis.

Prolonged and heightened market volatility has renewed the focus on margin costs across the Hedge Fund industry. At times when market factors lead to sudden deleveraging and reallocation of risk; Treasury and COO functions need to ensure margin jumps don’t generate additional drags on P&L.

A recent market study by Acuiti, on Margin Management for Hedge Funds, found some impactful themes supporting this.

• A recent market study by Acuiti, 
• A recent market study by Acuiti,
• A recent market study by Acuiti,