Banks are streamlining the services they offer the high-risk, high-reward funds by adopting ''cross-margining'' and 'cross-netting,'' where risk is calculated across a series of trades, instead of on a trade-by-trade basis.

This helps to lower the amount of cash a fund must set aside on margin as a kind of insurance policy for its banker, or ''prime broker.''

Creating systems that reduce investment risk and allow for a reduction in fees to customers will require a big investment, but the potential rewards make the effort worth it.

'The first [bank] to get there with a comprehensive cross-margining, cross-netting system will cannibalize the competition,'' said Andrew Sinclair, former co-head of hedge fund coverage at ABN Amro, who left last month to start his own hedge fund with a small group of investment bankers.

The need to adapt systems for hedge funds places a further heavy burden on investment banks, whose information technology costs are already steep. A bank can easily spend US$200 million (HK$1.56 billion) a year on hardware and software to stay on the cutting edge.

``Prime brokerage is all about improving technology,'' said a spokesman for one of the industry's largest players. ``There is a technological arms race that is ongoing.''

The cost of running a fully integrated prime brokerage, providing execution, clearing and leverage services, among others, can run into billions.

Hedge funds find it cheaper and more convenient to work through an intermediary. When banks first started acting as their traders and facilitators, they treated them much as they did any other customer.

Convertible bonds went through the convertible desk, currency trades went to the currency desk, and credit default swaps or warrants were routed to one of the derivatives desks - the bank collected a fee in each instance and there was little or no communication between trading desks. That might be fine for the banks' proprietary trading desks and their more traditional methods, but it works less well for hedge funds.

They often require multiple rapid trades in and out of a variety of instruments to achieve the big returns their investors expect. Running trades the old-fashioned way incurs a slew of fees that whittle away at returns.

Cross-margining and cross-netting are ``part of moving to a far more efficient platform for long-term clients by making [prime brokerage] more cost-efficient,'' said the prime brokerage spokesman.

Hedge funds are specialist investment vehicles, popular with high-net-worth individuals, endowments and institutional investors, that pride themselves on performing strongly in all markets, even those on the decline or trending sideways.

Historically low interest rates have pushed even conservative investors into the embrace of this high-return industry.

For example, the California Public Employees Retirement System, or Calpers, which is notoriously hard on fund managers who miss their targets, plans to double the amount it invests in hedge funds to US$2 billion, increasing its bets in both Asia and Europe.

Banks hope that besides offering clients lower fees, they will also be able to offer them a clearer idea of the risks inherent in their trading strategies.

When dealing with highly sophisticated financial instruments, even a few bad trades can incur huge losses.

Recent examples of trades gone wrong include China Aviation Oil's US$550 million in losses on oil futures, and the tens of millions of dollars in derivatives trading losses that forced Singapore's Aman Capital Management to stop trading and return money to investors in June.

Because of such risks, funds are required to leave cash on margin as insurance with each of the trading desks they use at their prime brokerage.

A desk that trades standard equities will require 10 or 20 percent of any transaction as a margin, while a foreign exchange desk may demand only 5 percent. Either way, it's cash that hedge funds can't use to generate profits. Cross-netting is one way to reduce the need for margining and leave funds with more cash to play with.

Prime brokers will perform a VAR, or ``value at risk'' calculation, to produce a kind of worst-case loss scenario, based on the full range of coordinated trades any one fund would employ.

``The combined risk may be less than the standalone trades,'' said Richard Johnstone of Albourne Partners, a hedge fund consultancy.

Any bank that can perform such cross-netting analyses will give funds a powerful incentive to use its services.

Morgan Stanley and Goldman Sachs stand head and shoulders above the rest in the prime brokerage arena, with an estimated 94 percent global market share, but UBS, ABN Amro, CSFB and others are building teams, setting up systems and luring clients.

As global hedge funds set up shop in Asia or trade Asian assets from bases in London or New York, the importance of prime brokerage services is growing.

Hedge fund trades need more leverage and other services than most, and often more than one prime broker is involved. Asian-based hedge funds are mushrooming, drawn to liquid markets like Singapore, which gives hedge funds preferential tax treatment, and Hong Kong.

All things considered, Asia is a hedge fund playground, with a dozen different currencies and regulatory regimes where nimble funds can extract profit by leveraging off the inefficiencies that exist in the region's developing capital markets. Asian assets under hedge fund management grew to US$60 billion last year from US$40 billion in 2003, says Eurekahedge, a Singapore-based alternative investment research consultancy. That is tipped to surpass US$80 billion by the end of this year.

Close to 120 new hedge fund managers are expected to begin managing Asian assets this year, and there will be plenty of new blood and new money in Europe and the United States too.

Because new means less experience and more risk, prime brokerages hope to use their advanced trading systems to poach other banks' larger, more seasoned clients as a hedge against their own risks in dealing with the neophytes. tim.leemaster@singtaonewscorp.com