In February 2008, I was hired as a strategic consultant by Eileen Murray, the ex-COO of Morgan Stanley, the then President of Duff Capital Advisors and the present "COO" (my definition, not Ray Dalio's, since he tends to avoid such titles) of Bridgewater.

One of the things Eileen wanted me to explore was the securities lending arena with the thought that next generation hedge funds could leverage the need for an improved risk and transparency offering. She directed me to Quadriserv, a start-up that was mixing it up between custodian banks, pension funds and prime brokers.

The Quadriserv team had been plowing the back 40 for six years pitching beneficial owners that the spreads afforded them by the custodian/prime broker oligopoly were too meager. Quadriserv’s lack of big capital was ostensibly the reason why their broker/dealer fell short on lending clients, volumes and revenues. The real reason seemed more to be the strength of the primes to protect their opaque profit center called sec lending.

Based on my knowledge of Bear Stearns’ numbers, prime brokerage profits were almost 25% of major investment bank profits. I believe as much as 85% of prime brokerage profits (some might say up to 110%) come from sec lending. Since annuity businesses like prime brokerage garner multiples of 3X versus the transactional or trading businesses of investment banks, by extension, sec lending might have represented as much as 50% of the core valuation of big investment banks. I'm too far away from custodian bank math to be as bold (I ran BTCo's sec lending franchise 20 years ago), but would anyone who works the custodian circuit deny the overwhelming importance of sec lending to profits?

Is it any wonder the oligopoly clung to its opacity like a cat to a curtain? The recent earnings at those investment and custodian banks that are heavily dependent on sec lending are being pummeled by this cyclically depressed sec lending environment and the new transparency trend. Surely much of this is from Dodd Frank and the Alternative Investment Fund Managers Directive, but the sec lending dry spell is playing a huge part as well.

The debacle in the cash collateral world over the past few years and the rash of lawsuits against custodian agent lenders is now a well-known phenomenon. Transparency is a word that stacks up with integrity, ethics, and apple pie, and nowhere is that more the case in the heretofore opaque worlds of hedge funds and sec lending. The prime broker world had its share of disruptions too. And Quadriserv launched their AQS Portal with minimal fuss and gains more traction every day. That’s a benefit to hedge fund COOs and beneficial owner CIOs alike.

When I spoke in 2008 at pension and consultant gatherings on the need for more transparency and attention to risk management in the sec lending process, I could see the steam coming out of the ears of custodians and primes. A funny thing is happening now. I have seen presentations recently from several major custodian agent lenders and lo and behold, they have bought the hymnal and are singing loudly to the choir. I'm not sure primes are altogether as chastised as custodians, but between new custodian pressures on transparency and hedge funds shopping primes (directly or with the help of S3 Partners), change is coming nonetheless.

Smaller sec lending slices for custodians and primes is clearly a good thing for both beneficial owners and hedge funds. My hat is off to Quadriserv and pros like Eileen for taking the arrows destined for pioneers....and still driving forward like the Road Warriors of the Transparency Wars that they are.



Rich Marin is the chairman and CEO of the Africa Israel Investment Fund (AFI USA), a major real estate investor in New York City. Prior to joining AFI USA, he was a consultant to a hedge fund. A former Bankers Trust derivatives executive, he was CEO of Bear Stearns Asset Management from 2003 to 2007. Rich Marin is also an Executive in Residence at the Graduate School of Management at Cornell University, the school from which he graduated in economics and from where he earned his MBA.