How well do hedge funds know their Counterparty Credit Risk?

S3 Partners, March 18, 2008 Summary: Hedge funds have an obligation to their investors to be aware of counterparty risks and obligations. The last few months have provided market participants with a reminder that counterparty credit should be actively managed and monitored. The disruption in the U.S. sub-prime mortgage market has served as a warning to the broader financial community including investment banks and hedge funds.

Specifically, hedge fund managers should pay close attention to the collateral rights and obligations that they have with their financing counterparts. While there is no quick solution to address all covenants pertaining to collateral rights and obligations, we believe that prudent hedge fund managers should put a robust process in place to address counterparty credit issues. The primary issues that need to be addressed are: (1) Market Driven Issue; (2) Single Counterpart Issue; (3) Consistency Issue; and (4) Cross Product Margining and Netting Issue.

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