SLT: HazelTree was formed after it was spun out from a hedge fund. Can you tell me a little about how the company was formed?
Casner: The reason behind the lift out was the technology the hedge fund had created – the fund had received several requests from other funds as to how to obtain that type of technology. At the same time, a private equity firm had a thesis that called for investment in next generation technology for hedge funds.
So the hedge fund and the private equity group together created HazelTree; that combination provided two advantages. First, we had the capital required for the commercialisation of the technology. Second, we created a “wall” between the foundation hedge fund and other potential clients who may have been concerned that their trading strategies and market views could be open to another fund - they now have the comfort that we are an independent technology company.
SLT: How has the technology evolved since the formation of HazelTree?
Casner: Any time a piece of technology is built for a single entity, it is built to cater to a specific set of business practices. And although hedge funds exist to manage significant holdings and generate large returns, they are usually small firms - mostly with staff of less than 100 - so they find their own best practices and focus on their own strategies.
Take for example the use of currency and managing FX risk. When hedge funds make bets internationally, some will take the sector view and the currency risk at the same time, while others don’t want the FX risk at all or just want to take on the risk in selected communities. So when we lifted out our technology from our first fund, we needed the system to be able to work through multiple strategies and types of risk.
The business was formed in late 2009 and we launched it in April 2010. We spent a lot of time re-engineering the technology so it wouldn’t just work for one hedge fund - we had to take in different types of investment strategies, counterparty relationships, different types of workflows and so on.
These tools are very powerful and very configurable and we have been able to launch funds on to the platform remarkably quickly.
SLT: Do the buyers need to take the whole system as an off the shelf product, or can they focus on the parts of it that they need?
Casner: There is a set of core tools that go across all clients and they are all about the data. It’s either about bringing data in or organising data from multiple sources. Once the data is organised, clients have a choice. Some use the cash management services, while others are less interested in that but need help in securities financing, cash reconciliation, margin or collateral management. We can deliver the power of the technology to provide a treasury function as an outsourced service, whole or in any part desired. We also provide an API for them to customise reporting and integration with other purchased and internally developed applications, making it a very compelling solution.
SLT: Are you targeting particular types of client?
Casner: There are three types of hedge funds. The first and most numerous are the smaller funds with only one prime or introducing prime broker and we don’t expect to attract that market. On the other side of the spectrum are the well established larger hedge funds with several billion in assets. Most of these firms have already recognised the value of treasury in their operations and have built solutions to help them. With those organisations we can help them go through their systems and define the value of their treasury operations - we can help them release the trapped value in their fund.
The key part of the market for us though is the mid market - those with over $100 million under management but less established than the largest funds in our industry. Once a fund gets over the $100 million mark, it has to deal with a whole set of new complexities, especially counterparty risk. This drives most funds to begin planning a multi-prime broker strategy. That is when the value of treasury accelerates very rapidly and that’s when the fund is under the most scrutiny from institutional investors. We provide those outsourced treasury services to these funds.
Whether funds use HazelTree or another provider, they should be thinking about their treasury the minute they go into a multi prime environment. If they don’t, treasury functions can have a lagging effect on the fund - it can create reporting and other data aggregation issues, which can drag down the performance.
SLT: How has the downturn
affected the industry?
Casner: Everything changed two years ago. Every major fund was watching counterparty meltdowns and suddenly realised that counterparty risk would make everyone reassess their banking relationships. We’re leading the effort to help sort out the complexities that arose from that transition, not just on the obvious risk issues but also how to leverage these new relationships to truly create performance gains.
SLT: How do you see the securities lending side of the market?
Casner: Securities lending is a fascinating business. It’s one of the few opaque parts of the trading business left to talk about. Every other type of transaction, be it futures, options and so on, has become commoditised. It’s impossible not to see how the last couple of years has affected transparency within the markets. But there is no generic market for hard to borrow stocks, and there is extremely limited access to market intelligence. And it’s difficult to borrow a stock outside an existing counterparty relationship.
At the moment, prime brokers gain a significant portion of their revenue from these types of transactions. We recently helped a fund analyse their short book and found a seven-digit disparity between the market rate and the amount the broker was charging. The broker said it was inherent in the nature of the relationship and those rates funded other services it provided for free. Obviously our client was apoplectic - more because such transactions could have serious compliance repercussions that come from such an arrangement. So we see it as our job to help provide that transparency.
The securities lending market needs to become more open. A lot of people – AQS, Astec Analytics, Data Explorers and the like - are trying to do that, but until hedge funds and prime brokers get on board it’s not going to happen. At the moment it’s the type of business that seems to be carried out in smoke-filled back rooms without any transparency.
Our purpose is to help the fund by providing data transparency, especially in the rate discovery phase of securities financing.
SLT: You recently brought on a new member to your board of directors from a major prime broker. Does that appointment mean a closer relationship with that one broker?
Casner: It will mean a closer relationship with all prime brokerages. We are actively building our relationships with J.P. Morgan, Morgan Stanley, Credit Suisse, Deutsche Bank, Fidelity, UBS, Merlin and many others. The appointment sends a message to the community that we are a complementary service, not a competitor - our competitors may feel that they have to “beat up” the prime broker market to provide better treasury services, but we disagree. We’re there to help hedge funds collaborate better with their brokers. It’s about enabling better relationships, creating stronger hedge funds and increasing performance while mitigating risk.
SLT: Do you have plans for the fund administration side of the industry?
Casner: At the moment we are focusing on three growth areas. The first and foremost is our treasury services, which are already proving successful. The second is agency lending. We believe there is a role for a next-generation exchange and while we will have partnerships and not get directly involved ourselves, we will play an active role in evolving that part of the hedge fund industry.
We don’t have any public plans for the fund administration sector, but I do feel that at the moment fund administration as a whole is broken and we can help enterprises get to the next stage.
Many hedge funds that self-administered came under huge pressure to outsource operations to third-party fund administrators. This meant the migration happened very quickly because funds had to shift the administration outside their walls to fund administrators who didn’t understand their strategy, business practices and so on. This creates errors in processing that the hedge fund has to go back and correct.
We believe that a true next-generation fund administrator will have technology services that leverage the fund’s expertise in creating efficient operations and data processing, while providing the proper, independent external audit and valuation services investors demand.
I believe the fund administration business is going to move in that direction over the next three years and I want us to be a part of that.
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