Prime BrokerageServices offered to large financial clients or hedge funds

Written By:
Lisa Borga

Reviewed By:
FundsNet Staff

Prime brokerage refers to a set of services offered by investment banks or other financial institutions to hedge funds or other clients with complex financial needs.

These services often involve custodial services, securities lending, leveraged trade executions, and cash management.

Prime brokerage services are provided by a number of large financial services firms, such as Credit Suisse, Barclays, Bank of America, Merrill Lynch, Goldman Sachs, Deutsche Bank, and JP Morgan Chase, among others.

Key Takeaways

• Prime brokerage is a suite of services offered by investment banks or other financial institutions to large financial clients or hedge funds.
• The services in a prime brokerage suite might include securities lending, leveraged trade executions, and cash management, among others.
• Financial institutions are required to have a minimum account size to conduct business with prime brokers, and this requirement varies among prime brokers.
• By using a prime brokerage service, large institutions can outsource a number of their investment activities. This can allow these institutions to focus more on their investment goals.
• Prime brokerage services can help hedge funds to access research, borrow cash or securities, and find more investors, along with other services.

Prime Brokerage Explained

Prime brokerage services consist of supporting the trading operations of hedge funds and large financial institutions.

A large part of this service involves permitting hedge funds to borrow stocks or other securities so as to help them increase their leverage, as well as being an intermediary between the hedge funds and the other parties involved in the transactions.

Prime brokerages, also known as prime brokers, are typically major investment firms or large financial firms that do business with hedge funds as well as other large institutions.

It is common for large banks to have a prime brokerage unit that provides prime brokerage services to numerous clients.

Prime brokerages offer numerous services, but clients do not have to select all of the services and have the option of having other institutions perform some of the services if they choose.

Prime Brokerage Services

Prime brokerages will generally offer their clients a suite of services.

Prime brokers sometimes provide large institutions with resources they don’t have themselves.

This can allow these institutions to outsource some of their investment activities and concentrate more on their investment strategy and goals.

Here are a few of the services prime brokerages may offer.

Securities Lending

Sometimes a financial institution may want to sell a security that it does not actually own.

When this happens, a prime brokerage can lend the shares or stocks to their client.

By doing this, the prime brokerage helps to make the market more efficient.

Custody Services

Prime brokers can also hold their customer’s securities, such as bonds, options, futures swaps, or equities, among others.

This means the prime broker is responsible for keeping these assets safe.

They also keep a count of these securities and often provide daily reports to their customers with a count of the securities.

Facilitating Trades

A prime broker can facilitate trades by acting as an intermediary to their customers, whether it is for fixed income securities, derivatives, such as credit default swaps, equity, or others.

Access to Research

Primes brokers often have their own research departments. So, they have an abundance of data available on many subjects. These brokers will frequently make this data available to their clients.

Administrative Services

Prime Brokers will often provide hedge funds with administrative services to help them reconcile their books on a daily basis and attain a daily Net Asset Value.

Therefore, they act as accountable bodies for the firm’s assets and make sure that no fraudulent basis exists for the reporting of numbers and values or for trades.

Capital Introduction Services

With this service, the clients are introduced to investors in order to help them find new sources of capital to invest in while complying with all applicable laws.

Cash Management

Cash management involves collecting and managing a company’s cash flows, and with this service, the prime broker helps the client with this part of their business.

Since these clients are only very large institutions, efficient cash management is essential and can help these companies remain stable.

Limitations of Prime Brokers

Although prime brokers can be a big help to their clients, they do have some limitations.

Only Provide Prime Service for Large Clients

Prime brokers often provide a large suite of services, but these are only provided to very large clients, such as hedge funds or other large financial clients.

But, this means small investment and trading companies cannot obtain these services directly through the prime brokers.

Insolvency

Some hedge fund managers are avoiding prime brokers due to the risk of the prime broker becoming insolvent.

Prime Brokerage Clients

Generally, the clients of a prime brokerage are large institutions or investors.

So, typically the hedge fund’s money managers or other professional investors looking for these services qualify for the services.

In fact, prime brokerage services are often thought to be an important part of a hedge fund’s success.

Other typical clients of prime brokers are commercial banks and pension funds.

These types of investors work with a lot of cash in order to make their investments.

Yet, they often fail to have the necessary resources themselves to manage their investments.

In order to obtain a prime brokerage account, a company is typically going to need at least $500,000 in equity, and this is not likely to give the company significant benefits over what it would obtain from a discount broker.

A number of the biggest prime brokers in the United States are investment banks.

Some of these are City Group, JP Morgan, Bank of America, and Goldman Sachs.

If institutional clients want to obtain the best services from having a prime brokerage account, including discounted trading fees, they are likely to need an account with at least $50 million in equity.

Still, prime brokerage services are quite popular, and the top banks will only take on clients that they believe will be of benefit to them.

Because of this, a hedge fund likely would have to have approximately $200 million in equity to actually get the best services from a prime brokerage account.

Example

Investment Bank Y offers prime services to hedge funds as well as other large institutional clients.

The bank will lend securities to these clients and also supply the clients with money for margin loans.

This investment bank also provides custody services to its clients in which it holds securities and is responsible for keeping them safe.

It also provides the client with a daily report on the securities to the client, which contains a count of the securities.

The bank also ensures that there are assets readily available to be used as collateral. By doing this, the bank can supply higher leveraging funds to their clients that wish to borrow them than they would be able to obtain from an average bank loan.

FAQ

What Fees Do Prime Brokers Charge?

The rates a prime broker charges are different for different clients.

Additionally, not all prime brokers have the same rates since each one sets its own fees.

The rates are also typically based on the number of services a customer makes use of or the volume of transactions a client engages in, among others.

Are Prime Brokers and Brokers the Same?

A prime broker is a large institution that offers a number of services, such as securities lending and custody services, to hedge funds as well as other large institutional clients.

In contrast, a broker is a firm or an individual that buys or sells securities for their clients.

What Is Included in a Prime Brokerage Agreement?

Prime brokerage agreements are agreements made between a client and their prime broker and include the services that the prime broker will be providing for the client.

The agreement also includes the terms, minimum account requirements, fees, required transaction levels, and other parts of the agreement between the two parties.

How Do Prime Brokerages Make Their Money?

A prime brokerage makes its money in a variety of ways. It has lending charges, charges different fees, and can charge a commission on its client’s transactions.

Final Thoughts

Prime brokerages act as financial intermediaries for their clients.

They provide a large variety of services to hedge funds and other large traders, such as custody services, security lending, trading services, capital introduction services, and many others.

By providing these services, they allow companies to outsource some of their investment activities, which means the companies can focus more on their core obligations.

The services these brokerages provide are important to the financial sector and help it to run more smoothly and efficiently.