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.
A family office is a vehicle established by a ultra high net worth investor to manage her own, and her family’s 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. 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 paramilitary organisation.
At one level, this is harmless, dull, 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 the the 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 one perfect storm of hyper-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 down 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 each of the brokers has an imperfect, asymmetrical view of their 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. The JC has no information at all: the suggestion is wild speculation; it seems unlikely and would surely fall foul of voidable preferences in most places, but there remains an uncomfortable technicality of corporate veil: the family office and its owner are different, legally segregated 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.