Segregated accounts: an uneasy compromise

The bank noted hedge fund managers were seeking to diversify risk by moving services to global custodians in a challenging market environment. "Counterparty risk is a heightened concern among hedge fund managers, who are assessing safekeeping options for their cash and other assets," said Jack Klinck, global head of State Street's alternative investment solutions group. "By combining traditional custody services with our full complement of middle-office, fund accounting, fund administration and risk services, we can offer our customers seamless service delivery through an integrated solution set."

As part of the extended offering, State Street's hedge fund customers have access to a range of products such as FX from State Street Global Markets, alongside deposit and custody services for cash, as well as securities processing and safekeeping globally.

The move indicates a continuing trend by banks looking to leverage the buy side's interest in parking collateral separately or externally, following the collapse of Lehman Brothers last year. Those that were exposed included MKM Longboat Capital Advisors, the London-based multi-strategy hedge fund group, which had to close its multi-strategy fund in part because of assets stuck at Lehman Brothers.

Diamondback Capital Management, a Stamford, Connecticut-based hedge fund, has reportedly said it had assets of $777 million stranded in Lehman after the bank's bankruptcy. Meanwhile, Harbinger Capital Partners, Amber Capital and Bay Harbour Management in New York, and RAB Capital and GLG Partners in London also had funds trapped with Lehman.

One head of trading said, while there has been a general improvement in the market environment, interest in segregated accounts is still evident. "What Lehman revealed was that a lot of clients weren't fully aware of the exposure they were running. So a lot of hedge funds, particularly those that use banks as prime brokers, are still uncomfortable about that," said one head of trading. "On the other hand, with segregated accounts come increased costs for everyone, including the underlying client. So it is a bit of an uncomfortable comprise as things stand."

So far the halfway house has been to keep collateral in a segregated account or escrow account with a charge over it. But there are rumblings of more innovative ways of protecting these funds.

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