1) Financing – margin, securities lending, repurchase agreements
2) Administration – trade support, clearing and settlement, P&L reporting, cash management, procedure documentation
While all hedge funds require financing, some perform their own clearing operations, while others hire a prime broker to perform administrative tasks. In today’s blog, we’ll discuss the three main administrative reports that prime brokers provide to their clients who are not self-clearing. Typically, the accounting department of the investment fund will reconcile the information on these reports to its own internal data, and take steps to resolve any discrepancies.
Note that although the reports are generated monthly for accounting purposes, they are available daily and even in real-time to support trading decisions and cash management activities. Also, the term “report” is really a throwback to when access to this kind of information existed only as a computer printout. In today’s world brokers provide this data online and through decision support systems. Snippets (small subsets of information) are often available as text messages.
Reports can be generated on a trade date or settlement date basis. Trade date reports show positions and P&L based on when trades executed. Settlement date reports take into account subsequent settlement activity, including trade failures, loans/borrows, and repos.
The three vital reports are:
1) The Trade Date Position Report – reports the open positions for each account within a particular fund or business unit. Open positions can be long or short. The report usually tracks cost and market value (in both local currency and dollars), and calculates both unrealized and translation gains/losses. The market value for each security is usually arbitrated using price feeds from several sources. The difference between the cost and the market value of security’s open position is recorded as unrealized gains/losses and translation gain/losses in the financial statements. This price-update process is referred to as mark-to-market and is a required accounting procedure for companies whose primary business is trading securities. The Position Report gives traders vital information regarding risk exposure. In some hedging strategies, real-time positions and market values are used to maintain an arbitraged deal correctly. For example, in delta hedging, traders maintain an offset ratio of options to their underlying stocks. Price movements trigger hedge adjustments, and the ability to extract a profit from a delta hedge position requires that traders have access to very timely information, such as that provided from the real-time version of the Position Report
2) The Trade Date Realized Report - reports all realized gains/losses that have occurred during the selected time interval. Realized gains/losses result from the closing of a position, as opposed to unrealized gains/losses which result from the mark-to-market of an open position. Most systems calculate realized gains/losses on a first-in-first-out basis. Traders keep close tabs on the Realized Report, as it is an indication of the success or failure of a trading strategy – a prime determinant of trader compensation. Every trader has a vested interest in verifying the information in the Realized Report, especially if a clerical error understates a trader’s realized P&L.
3) The Cash Activity Report reports opening and closing cash balances for each trading currency by account and all the corresponding transaction entries that affect cash during the time period for which the report is run. This information is vital for the personnel who manage the trading firm’s cash. Cash managers are responsible for the optimal deployment of cash to minimize financial expense, maximize interest income, ensure adequate balances for upcoming expenditures, satisfy collateral requirements, and to make sure every last dollar (or euro or yen) is being put to good use.
Of course prime brokers can and do supply their clients with dozens of different reports, feeds, and screens. But the three reports we’ve described here form the information foundation that non-self-clearing hedge funds and other trading firms rely on from their prime brokers.
Based in Chicago, Eric Bank has been writing business-related articles since 1985, and science articles since 2010. His articles appear on eHow and on numerous other websites. He holds a B.S. in biology and an M.B.A. from New York University. He also holds an M.S. in finance from DePaul University.