A leading hedge fund has called on beneficial owners and agent lenders to adapt the way they conduct trades to alleviate pressure on broker-dealers’ balance sheets.

Capital rules under Basel III have made it expensive in balance sheet terms for broker-dealers to engage in the practice of facilitating securities lending, as the intermediary between the agent lender and hedge fund.

Phil Prince, managing director and head of treasury, Pine River Capital Management, said: “The constraining factor in a Basel III world is the broker-dealer balance sheet.”

Broker-dealers’ balance sheets have become a major constraint on the ability of asset owners to earn an extra return on their assets and for hedge funds to be able to take short positions.

Prince, representing the multi-billion-dollar international hedge fund at the IMN US Beneficial Owners Conference, added: “This piece can be very efficient in a Basel III world. But the other piece can be very inefficient.

“The extent to which beneficial owners can make their half more efficient, anything that that makes that side more efficient, will make the entire picture work better. 

For example, routing trades through a central counterparty (CCP) between the agent and broker-dealer massively reduces the capital cost for the later, in comparison with bilateral arrangements.

He said there was a limit to how much more efficient the interaction between broker-dealers and hedge funds can be made: “We believe that we have come close to that limit.”

“The bottom half of this picture is very balance sheet inefficient for the broker-dealer community – and its in your hands to make it more efficient.”

While he acknowledged that the legal and governance issues would make it near impossible for beneficial owners to deal with hedge funds directly, he said: “There are things you can do now that will begin to make that more effective, to make it possible to do more of the entire picture .”

Lance Wargo, North American head of agency securities lending, BNP Paribas, added that this is an issue on which agent lenders such as himself and fellow panellist Peter Bassler, managing director, business development, eSecLending, are engaging with beneficial owners. “This is were we have to educate our clients, and talk to other providers out there. This is where we need to get to."