The following document is an approximate, but not exact, transcript of the Operational Leaders podcast conversation between host Terrance J. O’Malley and guest Poseidon Retsinas.
Please support the production of this podcast by downloading the Poseidon Retsinas episode.
Welcome to the Operational Leaders podcast featuring leaders and innovators in the investment management industry, where we discuss the business of running the business with host and top industry executive Terrance J. O’Malley.
Terrance O’Malley 0:19
My next guest is the founder of HedgeLegal, a law firm dedicated to negotiating trade agreements exclusively for the buy side. He has over a dozen years of experience working for top industry organizations overseeing counterparty documents, including ISDAs, prime brokerage and custody agreements. He is one of the top up and coming leaders in trade agreements and onboarding. Please welcome Poseidon Retsinas.
Poseidon Retsinas 0:44
Hey, Tery, thanks for having me.
Terrance O’Malley 0:45
Hey, it’s great to have you here today. Tell us about your business.
Poseidon Retsinas 0:48
So I’ve launched a law firm which is specialized and focused on helping the buy side negotiate its trading agreements – so prime brokerage, ISDAs, futures, repo, pretty much across the spectrum. The reason I’ve done this is I really think that there’s a gap in the market where hedge fund managers and others on the buy side are not getting the support that they need across the spectrum of the legal as well as the operational elements of the onboarding [process]. Also, I believe that these agreements can be expensive to negotiate. And when you have counsel that’s not very familiar with the intricacies of the document, that doesn’t have a lot of experience with market practice, then the negotiations can drag out for much longer than they need to be. So with our expertise, we’re able to offer great terms, solid negotiation, and also do it in a shorter time frame.
Terrance O’Malley 1:32
So these things tend to be really expensive. Why is that?
Poseidon Retsinas 1:36
Well, there’s a number of reasons. I think the first thing is, the documentation can be rather complex and long winded. But what usually happens is being from the buy side, hedge funds, receive the documentation from the prime brokers or their ISDA counterparties. And the documentation starts very heavily slanted in favor of those counterparties. They are, you know, helpful service providers and they’re really great partners to hedge funds. But let’s remember that they’re running their own business and they’re protecting their interests. So they’re looking for as many ways out of a relationship as possible, to have as many options open to them. And then in terms of the negotiation, going through the process of marking-up the document, sending it back, and the back and forth that ensues can take a lot of time.
It depends on the willingness of the counterparty to negotiate. So for larger managers with more bargaining power, you can achieve terms quicker and get to better terms. If you’re a smaller manager, you may need to push a little bit more to try and achieve similar success. And so there is this amount of time and energy that needs to be put in to go through the dance of the back and forth of the negotiation, and the little push and pull of that negotiation. So that can take a lot of time and it takes a lot more time when counsel or advisors to the fund don’t really know what the most important issues are and aren’t able to cut to those points quickly.
The other thing that’s really important is to know the boundaries within which the various prime brokers on the street are willing to work within. Each of them has their own intricacies and nuances. So the terms that you can get out of one, PB may not be the same as another. So knowing where the sensitivities are, and what they’re willing to give on can also help you get to those terms quickly.
Terrance O’Malley 3:12
How much of this is a question of educating your client in terms of how big they are, what their negotiating power is, what they can reasonably expected to get?
Poseidon Retsinas 3:20
Well, that’ll depend largely on the type of client or the type of hedge fund. So the larger more established funds that I work with usually have more experience in these agreements. They’ve already done a number of them. So they know. They know the boundaries quite well. And when they’re looking to me, they’re looking to refine that approach. And to go further and to help assist them with the time that’s needed to really negotiate. For smaller managers, for startups, there’s a lot more needed in terms of the negotiation.
For managers that are just starting out that were portfolio managers, and they’ve never actually run a hedge fund or been involved in-depth in a document negotiation, all of this seems a little foreign to them. They don’t really know what they should be asking for, why it’s important. So for those types of clients, I spend a little bit more time sitting down with them and explaining, this is how the document works. This is what’s really important. This is what we’ve been able to achieve, and where we haven’t been able to achieve something. This is why and this is where your risk now lies. And this is what you should be mindful of.
Terrance O’Malley 4:15
So you’re a business guy, as well as an attorney. Talk about the business model of representing just the buy side and focusing more or less exclusively on counterparty agreements.
Poseidon Retsinas 4:27
Sure. So representing just the buy side is important to me because I feel I can fully represent their interests and I’m never caught into a conflict. And my firm is never caught in a conflict situation where we may have been assisting one of the prime brokers on the other end in any way. So that’s one. The second is we’ve decided to focus exclusively in this niche because that’s what we know best. And that’s how we’re able to best serve our clients. We thought about going broader and doing fund formation and other parts of the business. But to be perfectly honest, that It’s not really our area of expertise. But also we feel that that’s an area that’s very well served by the existing law firms. They provide great service and great advice. And I think they’re very well suited to provide regulatory advice and to assist with fund formation.
The other thing that I’ve noticed is that funds will often want to have a white-shoe law firm name on their fund offering documentation, which I think is probably helpful, especially when they’re trying to attract larger institutional investors. So I think there’s a lot of reasons there, why it’s still relevant for some of these firms to pay the larger price tag and go to the bigger firms. But when it comes to the document negotiation, the expertise exists at most of these firms. But it comes at a much higher price tag, because they’ll charge it hourly rates. But also I feel that there aren’t necessarily that many lawyers in private practice that have worked on the buy side. There are some. But a lot of times hedge funds may be working with a lawyer who’s never worked in-house on the buy side and doesn’t really understand the realities, and can’t really help them with the broader picture of the onboarding which the legal aspects of it is one thing. But there’s a lot more involved in terms of how do you approach your counterparty to start the onboarding and the negotiation? What happens during the life of an on-boarding? What are the other things that you’ll need to get as a fund, like your legal entity identifier number? Do you need to adhere to ISDA protocols? Do you need to complete market Counterparty manager, the OCR portal? There’s a host of other elements to the onboarding, that it wouldn’t make economic sense. But it’s also something that the law firms aren’t really well-suited to service because they haven’t necessarily been on the buy side.
Terrance O’Malley 6:35
So if I’m a client, it’s going to be easiest to go to one law firm and get everything done there. Your argument or your value proposition is that between your knowledge and the cost savings, the efficiency you bring, that you are a value proposition for people to seek out and find you.
Poseidon Retsinas 6:55
That’s exactly right. The value proposition is pretty compelling since we do things at a fixed rate. So our clients know upfront what it’s going to cost them to negotiate any number of agreements. For new launches that have multiple prime brokers or multiple counterparties that they need, I think that’s where we can really add a lot of value. Because, for us, there’s a lot of efficiency. If a client asked me to negotiate one ISDA or two ISDAs, there’s, not that much efficiency. For me, it takes me a lot of time to get to know the client – what their concerns are, what their needs are. But for a client that needs three prime brokers, a few futures clearers, a handful of ISDA counterparties and repo counterparties, I can take that whole project for them from start to finish, reach out to all the counterparties, manage the onboarding process, get them great terms and do it at a at a much lower rate. And at a fixed rate so that for them, it’s really compelling.
Terrance O’Malley 7:43
So let’s get back to that in a minute. We’ll talk about counterparties and why people might have so many of them. But why don’t you give us a little bit of your background. Tell us how did you get into this business?
Poseidon Retsinas 7:55
Sure. So it kind of in a sense, it happened a little bit by mistake. I started out as an M&A lawyer, aspiring M&A lawyer, mergers and acquisitions, thinking that, you know, I really loved companies. I love the markets. I love finance. And I thought that was probably the right way to go for me. I soon learned that it really wasn’t for me. It was actually quite disappointing. So the law firm that had hired me as a student didn’t renew my contract when I became a lawyer. So my hopes and dreams of becoming a big M&A lawyer at this big law firm were quashed at a very early age. I was really disappointed. But I was also kind of disillusioned by the whole practice of law because I really didn’t like what I had done up to that point.
Within a couple of weeks after not getting that offer, not staying on at that firm, I had an offer from a major law firm in London, Clifford Chance, to go work in their derivatives practice. This was in 2008, early 2008. So before the crisis or the liquidity crisis that led to the financial crisis had started. And London firms were hiring lawyers from pretty much across the globe. But certainly bringing in a lot of hands there. So that was a great opportunity for me. I had already studied at the London School of Economics prior, did a master’s degree there. And so going back to London to work was really appealing. That was a fantastic experience for me. When I went to Clifford Chance, things were booming. Clifford chance had its own 30 story tower. It still has in the in the Canary Wharf district of London, which was new, quite new at the time. And it was quite an interesting place to work, high level of expertise. But also, they really took care of their people there. I learned a ton while I was there. I loved the practice. I became a budding expert in derivatives.
And after spending a few years there, I found a great opportunity to go back to my native Montreal and work at Innocap. Innocap is a hedge fund managed account platform which managed about 7 billion the time that I left with about 50 managers on that platform. So over the years at Innocap, I worked and on-boarded with around 70 managers. I worked with great allocators, notably the Canadian public pension funds and all the prime brokers. So the model, a big part of the model there was that the managers that would come onto the platform, Innocap and the funds that we would put in place would replicate their trading environment. [That] meant that gave me and the team that I was managing a lot of exposure to pretty much every prime broker across the street. So over time, my role at Innocap evolved into doing more than just the legal negotiation, but also handling all the aspects of the on-boarding and even selecting prime brokers, which was really interesting and gave me a new look on the business.
So after about nine years at Innocap, I decided to launch HedgeLegal for the reasons I already mentioned earlier.
Terrance O’Malley 10:41
So you mentioned you’re based out of Montreal. Wall Street is everywhere, isn’t it?
Poseidon Retsinas 10:46
It is it is indeed. And even though I’m based in Montreal, the work that I’ve done over the last 10 years has mostly been with banks in New York and mostly with managers in New York. So certainly the hedge fund industry is really headquartered out of New York. So regardless of where you are in the world, and allocators are all over the world, there’s a lot of attention and people are looking at managers here in New York.
Terrance O’Malley 11:09
But you can be anywhere to do this business,
Poseidon Retsinas 11:12
I believe you can be, absolutely. I think you can be anywhere. And I think the way clients, and at least in my experience, the way clients are looking at the services that we provide, they don’t really care if I’m located in New York. I come to New York frequently, I meet with them. We have calls, everything’s done over the internet, obviously, in emails and conference calls. So you don’t really need to have a big office in midtown Manhattan, to be able to service clients. And quite frankly, to the extent that you don’t have that, you are able to save and pass those savings along to your clients.
Terrance O’Malley 11:42
So let’s back up a little bit. Let’s talk again about counterparties and the counterparty business. If you’re a manager, you’ve got a lot of these people. Who are they, where did they come from, and why in some cases are there so many of them?
Poseidon Retsinas 11:57
Let me tell you a little bit about the history of prime brokerage and how it evolved. And that’ll help explain why there are so many and who they are and what they’re doing. So the first hedge fund is credited, largely credited to Alfred Winslow Jones in 1949. Equity long-short. Back then there were no prime brokers. There were obviously brokerage houses. So what this meant is that early hedge funds needed to use multiple brokers to execute trades. But they also had to maintain accounts at each of them. So they had stocks through them, and which made the process of reconciliation and keeping track of their assets more difficult. In the late 1970s, the prime brokerage model started to emerge, and it became possible to have one central broker where all your assets and trades would feed into. You could still use the other brokers to execute, but all the trades would settle and clear at one prime broker. This prime broker was also providing financing. That’s a cornerstone of the prime brokerage business. So it helped to have this at one place.
As hedge funds proliferated in the 90s and 2000s, the PB model and the PBs became more important, and became a more part of the business of the investment banks. Their services and the products that they offered also increased over time. So we started with just equities. But then it expanded over into fixed income, futures and options, derivatives and equity swaps or synthetic prime brokerage. Beyond just what they’re offering in terms of financial instruments that they can work with, they also provide other services. I mentioned the financing. They provide locates on shorts, trade execution. And then even services that are ancillary to that, like hedge fund consulting, cap intro, and even technology, research and corporate access. So the prime brokers – and particularly the bulge bracket prime brokers – offer a broad range of services to hedge fund which can be really helpful to them.
In the 2008 financial crisis and the collapse of Lehman, [that] was a really sobering experience to the industry. Barclays purchased Lehman, JP Morgan acquired Bear Stearns and Bank of America acquired Merrill Lynch. There was a real shuffle in the prime brokerage space. But also the collapse of Lehman showed that there is a weakness in this PB model that even the biggest institutions can fail. And this led to a diversification. Clients starting to diversify and use multiple PBs, but also made them aware of (and a little bit more concerned about) asset control and the terms of their agreements to make sure they really understood what the risks were.
Fast forward to today, we have the bulge bracket prime brokers, which service the larger clients, larger hedge funds. You have what’s called secondary or smaller prime brokerage that can service across a wide range and still help some larger, but also smaller hedge funds. And then for the smaller hedge funds, there’s [been] over the last decade or so the emergence of mini primes, which are basically smaller shops that aggregate balances from different clients and then face off to one prime broker. So they kind of introduce you to that PB, you don’t have a direct relationship with the larger prime. You go through this mini prime broker.
Beyond just prime brokerage, we also have other types of services or trading type of agreements. There’s futures clearing, so futures clearers. You have ISDA counterparties, which is not a prime broker just for derivatives, repo counterparties, custodians. So there’s a host of different services that are provided as part of the trading agreement umbrella.
Terrance O’Malley 15:16
Okay, so let’s keep this simple. Let’s focus a little bit on the prime brokerage agreement. And you mentioned earlier, there’s negotiation that goes on in these. What are some of the key terms that people look for? I mean, I’ve seen some of these documents, they’re huge. My eyes water over and I quickly say, “I better find somebody who knows what they’re doing here.” What are some of the key terms and what do people really negotiate over?
Poseidon Retsinas 15:41
So when approaching a prime brokerage agreement, the first thing I think any manager needs to be thinking of is what are you looking for. As a manager, you’re looking for stability, you’re looking for service, and you’re looking to get it at a good rate and to have efficiency in your margin. So the first thing you need to consider is, do you have a lock-up or a commitment from your prime broker as to the length of the term of your financing? So particularly if you’re an equity long-short manager, and you’re using a reasonable amount of leverage, you want to make sure that borrowing that you’re taking from your PB, that you have stability and that you can keep that for a certain term. The baseline starting point of any prime brokerage agreement is that financing is done on an overnight basis, which means in an un-negotiated form, the PB can pull that financing from you at any time.
Terrance O’Malley 16:26
Yes, that can be a problem. If you have a longer-term strategy, there’s market disruption, your PB calls you up and says, “By the way, that overnight financing is no longer valid.”
Poseidon Retsinas 16:34
Exactly, exactly. The second thing is, how is the margin requirement being determined? And does that margin requirement also tie into your lockup. So it’s key. It’s key to know how the margin will be determined and also know that the prime broker can’t change the method with which it’s determining that margin. Again, the starting point in a PB document negotiation is that margin can be determined in any way on a discretionary basis by the prime broker. Which means from one day to the next, they could call you for any amount of margin, forcing you again into the situation where you may need to liquidate positions.
The final thing is the third point is when something actually goes wrong. So the first two points – the lock-up and the margin requirements – we’re talking about nothing having gone wrong at the fund, regular course of business. The last element is what are the events of default or the “termination events” against the fund, like when something happens, something goes wrong at the fund – if there’s a payment failure, or if a key person has left the fund, or if there’s a breach of, of investment guidelines. Do those situations give rise to the right for the prime broker to terminate your relationship? Again, the starting point in these prime brokers negotiations, the agreement is heavily stacked in their favor, giving them many, many ways to pull out of an agreement. So looking at those events of default is crucial. And there are a number of things that can be easily obtained if you ask for them. For instance, getting an operational error carve out for a failure to pay. If you missed a payment, but the money was actually there, but there was an operational technical error, that shouldn’t give rise to an event of default.
Terrance O’Malley 18:02
So within that broad category of defaults, there are a number of points that typically get negotiated.
Poseidon Retsinas 18:08
Absolutely, absolutely. The other part related to those termination events or events of default is getting what’s called the “fish or cut bait” or a “sunset provision” into the document, meaning, if an event of default happens today, but it gets cured down the road, you want to make sure that the ability of your prime broker to call that event of default in the future is limited. If you don’t have this limitation, an event of default that happens today could theoretically be triggered and used a year or two down the road. So these are risks. These are gaps that that should be closed. But again, you need to negotiate and ask for it.
Terrance O’Malley 18:40
And some of the negotiation depends on your client’s leverage in any particular situation, primarily the amount of assets they have with the prime broker, but there might be other factors as well.
Poseidon Retsinas 18:52
Absolutely. The business case that the prime brokers are making internally is going to dictate in large part what type of terms you can get. What do you represent from a revenue perspective? But also, what is the impact on the balance sheet to the PB? So there’s an analysis to be done there. There’s the credit profile, the credit risk of the fund, that’s also really important. Remember that the credit departments at these prime brokers are independent functions. So even if you’re a great business, if it’s a really risky strategy, the credit department may insist on retaining a lot of these events and triggers, and credit terms.
Terrance O’Malley 19:26
So part of your value add is you know your clients, you know the prime brokers, you have a good sense of what’s market, you can kind of cut through some of that negotiation because you know what people will likely get?
Poseidon Retsinas 19:37
Terrance O’Malley 19:40
So, lets talk current events. We’re obviously in the middle of a global pandemic. Its impacted just about every aspect of life and business. How has it impacted counterparty relationships and the agreements that you’ve worked on.
Poseidon Retsinas 19:49
The first impact that we’ve seen is that its slowed the onboarding process at the banks. Overall working from home or working remotely has slowed the efficiency of those teams. And we’ve also seen that its slowed the ability of investors to move on new allocations. So new fund launches are still moving forward, but they are moving forward at a slightly slower pace. The other thing, the big impact that we’ve seen is the flight to cash by investors. A number of investors have starting redeeming, they’re looking to get into cash. They’re worried about how deep the downturn could go. And similarly, managers have been moving into cash, some manager have. So we’ve seen a little bit more flows into that and to money market funds. And hence more work has come in terms of setting up custody accounts.
The other impact we’ve seen directly in the PB space is with respect to the financing rates and margining offered by prime brokers. So overall, the prime brokers are tightening up a little bit. They’re looking for more margin. And they’re not offering the same pricing and terms to new clients as they were offering just a few months ago. So those are some of the main overall impacts.
So then if we turn to just talking about the agreements themselves, the counterparty agreements, and the prime brokerage agreements, have these agreements really been put to the test yet? What have we seen? Overall, I see the biggest focus there has been on NAV triggers. These triggers are contained in the ISDAs and a number of other trading agreements. And they are linked either to terminations, leaving a fund vulnerable to being terminated if there NAV has declined, or being subject to no longer having a margin locked up or other financing terms locked up. So a number of funds have hit these triggers due to performance, others based on redemptions. And I think there will be more in the future based on redemptions. So there has been a lot of discussion around that. It ties in back to the increase in margin. So if you’re a manager and you’ve hit a trigger. You’re bargaining power when your prime broker is asking you to increase your margin is limited. You’re holding a weak hand. So a lot of managers are looking at reviewing their triggers in their agreements, resetting them if they’ve hit triggers or seeking waivers. And finally, ending some of their agreements if they expect to hit triggers in the future to avoid it altogether.
The other area on the PB space where there has been more talk lately is on PB asset protection, rehypothecation. So this was obviously a huge area of focus post 2008 and the Lehman collapse. Unlike 2008 this crisis now is not really a financial crisis at its core or a banking crisis the way 2008 was. But there may be as the overall economy starts suffering, there could be trickle down to the banks. So a number of managers are taking this opportunity now to review these agreements and really understand the credit exposure and the risks lying within these agreements. So that’s another area where we’ve seen increased activity.
Terrance O’Malley 22:42
So taking into consideration coronavirus and some of the developments before all this happened, what are some of your thoughts on the future? What are some of the things we are going to see?
Poseidon Retsinas 22:56
So on the coronavirus itself, I expect a fairly deep recession. I think this is going to be worse than 2008 in terms of its impact on the overall economy. Its obviously disrupted the traditional ways of working and doing business and interacting with people. So that’s going to have lasting effects. Remote working I believe will be on the rise and will stay there for some time and will change into the future. The trend toward legal and operational workflows will likely continue.
With respect to overall, onboarding and negotiating, I expect managers to continue to look at multi-prime and multi-counterparty scenarios. The regulatory and KYC has increasingly become difficult and I believe that will continue. So onboarding remains a pain point and a lengthy process.
Some good news that’s come out of the crisis is that some regulatory changes have been pushed off or delayed. So the uncleared margin rules, Phases 5 and 6, which were supposed to come – Phase 5 was supposed to come in to force this year in September 2020 and Phase 6 in the following year – have been pushed back by a year respectively. So that’s given much needed relief to the industry. And I expect the uncleared margin rules to probably become a hot topic early Q1, 2021.
The final point I’ll make is just on hedge fund performance. We’ve seen a number of funds perform very well. We’ve seen other funds not perform so well. So this looks like it will be some type of extension of that within the industry, where there is going to be some big winners but there will also be a number of managers that sadly will not come out of this crisis. So I expect that once things start normalizing and settling down managers that have weathered the storm well will increase their assets. And I think there’s going to be a lot of opportunity for new fund launches where investors are going to be rushing in to take advantage of new opportunities.
Terrance O’Malley 24:41
Thanks for coming by today. This is an area that is complicated, it is detail oriented, and the details really matter. So thanks for shedding some light on it today. And if people want to find you, where can they find you?
Poseidon Retsinas 24:54
HedgeLegal.com. Thanks so much for having me, Tery. Its been great to be here.