Risk vs Reward – a delicate balancing act

A combination of Prime Brokers and Custodians on a panel discussing Risk vs Reward definitely made for good debate especially on talk of custodians raising fees and fee split. Gareth Mitchell, Citi, set off the discussion by making the key point that all lending agents are different as they all have different business models and cannot be put into the same basket. Therefore, lending agents business models and if they are under strain need to be evaluated individually. Agent lenders are increasingly competing on price rather than business models. It is understood that margins have been squeezed over the past few years but it is key to look at what is happening in the market and programmes must be adjusted accordingly.

Frederick Nadd-Aubert, Credit Suisse, believes that fee split is only one component but when speaking with a client the bottom line is the key point to look at. Discussion in terms of flexibility, risk and rewards and cash reinvestment is increasingly discussed with clients as they are more engaged and in the know-how than prior to the financial crisis. However, there are many factors that come into play when determining a fee split.

The panel was in general agreement that the current balance of risk and reward is fair and working. Sinclair Scholfield, State Street commented that is does depend on the structure of your programme. Essentially, agent lenders require skill in the game to go after the most profitable return for the client.

Gareth weighs up that risks are well identified and explained to clients but also the mitigation that is put into place. Clients must understand what the risks are and this works on an individual basis as some are more experienced and knowledgeable of the market than others.

Thoughts across the panel towards whether a change is required in the lending agents business model tended towards the model not changing and that it is in fact here to stay. It allows an agent lender to capitalise on competitors and other befinifical factors of growing and diversification.

The current environment of low cash reinvestment and low interest rates has given rise to intrinsic lending. The implications of Agent Lenders seen to be squeezing every last drop out of the intrinsic lending fee were considered including Hedge Funds resisting putting on short trades to the prohibitive cost of carry. It was concluded that with the lack of cash in the market, lending agents business models are under strain and are forced to increase efficiency. This issue will fade if and when cash reinvestment returns to ample levels.