Family office
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Hedge Funds & Prime Brokerage Anatomy™
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Another one of those things, like LIBOR and supply chain financing that seems so ordinary, unfussy, sensible and harmless; that, in its way, points up the holy terror of non-linear interactions in financial markets.
Like hedge funds, but —
Normal investment funds — even hedge funds — are somewhat arm’s length: there are checks, balances, and third parties involved with grave responsibilities, large sums of money and so on, and if anyone is cavalier things — and regulators — can get ugly, fast.
Financial services regulators care about the fragile interests of the poor, defenceless super-rich; they presume that grizzled old broker-dealers who service those needs can look after themselves. This has not always proven to the be the case, but still.
Investors are generally diverse, and different people to the investment managers, and for everyone’s peace of mind there are rentseekers agents employed make sure things are done properly. Custodians, depositaries, fund administrators supervise subscriptions and redemptions, manage account movements and calculate NAVs; all are distinct from the investment manager and each is likely to have its own compliance and operations teams. These agents ensure everything is done as it is meant to be, and that the auditor can easily sign off the accounts.
Because there are no third party investors, a family office is different. Is a vehicle established by an ultra high net worth investor to manage her own, her family’s and, on occasion, her friends’ unfathomably huge stacks of money. How the other half lives, huh?
These people move in circles mere mortals cannot imagine: they have enough dough to employ their own financial wizards to work it to their great advantage. Sure enough, like gulls around a seaside chippie, the rentsmiths soon arrive: an office manager, some operations people, a general counsel, and before you know it they are have a full-scale para-military organisation.
But it isn’t quite the same, if it is all in the family: these gatekeeper roles feel a bit plastic; a little play-people: if anything really goes tetas arriba, there aren’t any outside investors who might complain: just the boss. That a GFO has its own GC, an operations team and a Bloomberg terminal is a bit of a status-signal; a sign that it’s properly in the big league. So, you might see some of these roles doubling up: the same guy who invests 50% of the fund is also director of the fund company, and CIO of the investment manager, and his playboy son who did a semester of business law while at film school gets to be GC.
I am making all of this up, needless to say. But you get the picture. It’s Doctors & Nurses stuff for the oligarch set.
When wealthy families attack ... each other
Now sure, blood is thicker than water, and everything, but that only takes you so far, and when rich families do fall out, it can be spicy. This can put bona fide external counterparties in a awkward position: they may be managing a long-dated, levered $500m portfolio only to discover that Lorenzo is no longer talking to Giuliano, young Bernardo the GC hasn’t been seen since embarking on a 72-hour coke-fuelled bender in Casablanca three weeks ago, their main position is tanking, you can’t get any instructions, and while common sense would recommend that, for the purpose of not losing even more money they should talk to each other to agree what to do, they won’t.
This leaves their poor broker in an invidious position. To whom should it listen? What can it do? The cold logic of the situation says, “close the relationship out” — this is prudent, but may upset the seventh wealthiest man in Florence, and more importantly, his senior relationship manager in the private wealth management division.
The Voldemort factor
Still, internecine squabbles don’t happen that often, and as long as they don’t, at one level, GFOs are harmless, dull and dreary: well, not dreary, exactly — it’s hard not to be a bit glamorous when you have a superyacht in Monte Carlo and your own Island in the Caribbean — but for a prime broker these are like hedge funds, only smaller — usually smaller; not always — and with no outside investors making them all the more harmless: no ERISA money, no — well, limited — AML worries, no sudden NAV drops on account of precipitate withdrawals from dissatisfied investors. Just steady sailing from a super wealthy fellow running her own money, and therefore well-incentivised not to throw it around.
All that passed for conventional wisdom until late March 2021.
We know now, thanks to the gruesome CS Report on Archegos that family offices present other risks: “key man reliance”, “volatile performance”, “mediocre operational management practices” and “poor risk management practices and procedures”. And the “potential fraud risk is higher for a family office ... than for a commingled fund managed by an SEC-registered investment adviser.”
Well, all of those things, presaged and recorded on the permanent record by wise but now departed risk managers, came together in a perfect storm of pressurised apocalypse when a family office called — well, friends: being a horcrux, you won’t be surprised to know that, in the virtuous circles that comprise the financial markets, it is spoken of only in hushed tones, beneath grave countenances, and obliquely, as the client who shall not be named — went up in a carbolic smoke ball, taking the thick end of $10 billion of prime broker capital with it.
There was a further risk, not adverted to in the CS Report on Archegos but idly speculated upon in the financial press by those with a taste for schadenfreude: did TCWSNBN lose all its money, or did it somehow manage to squirrel some of it away?
We know the family office withdrew all its excess margin from a number of brokers in the days leading up to the catastrophe — it is presumed, to meet margin calls coming in thick and fast from other brokers. But every broker has an imperfect, asymmetrical view of the customer’s behaviour: it sees money going out the door; it does not see to whom.
Now it is one thing to rob Peter to pay Paul, as the saying has it. But to rob Peter and Paul and then kick the balance out to the sole shareholder in a dividend... would that be brass of a whole different ball game, wouldn’t it? To be clear: the JC has no information about this at all: the suggestion, made elsewhere in the press, is wild speculation; it seems unlikely and would surely fall foul of voidable preferences in most places, but it remains an uncomfortable technicality of corporate veil: the family office and its owner are different, legally distinct persons. At first blush, the prime broker’s straightforward contractual claim is limited to the net assets of the corporate entity to which it is contracted.
It would make a great play.