Prime brokerage refers to a combined set of services offered by investment banks or other financial institutions. These services are commonly offered to hedge funds or other investment clients that are looking to borrow large amounts of securities, in order to be able to partake in netting and thus achieve absolute returns.
Prime brokerage services can also aid lenders in accessing research and finding new investors.
However, some prime brokers don’t focus on their client’s asset size but rather provide their services based on their client’s business needs. Such an approach enables even smaller-scale businesses to receive the same type and quality services as those offered to far larger institutions.
Prime brokerage services most commonly include securities lending, but they can also include the execution of leveraged trades, cash management, seamless onboarding of new accounts, as well as a robust middle and back-office support.
By relying on prime brokerage services, large institutions can more easily outsource a portion of their investment activities which will, in turn, enable them to pay more attention to their investment goals and strategies.
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Understanding prime brokerage
Prime brokerage services focus on helping large financial institutions and other businesses manage their trading operations more easily. What this means is that, for instance, prime brokers will enable hedge funds to borrow the necessary securities to increase their leverage.
Simultaneously, prime brokerage services will also act as an arbitrator between hedge funds and their counterparties, such as commercial banks or pension funds.
Most commonly, large banks and similar financial institutions have their own prime brokerage units which take care of hundreds of clients.
Clients can opt to have some services performed by prime brokers while having others delegated to other institutions. Such flexibility is one of the main reasons prime brokers are so sought after.
Prime brokerage services
As mentioned earlier, prime brokerage services are available to all qualifying clients. The assigned broker can provide various financing services, as well as offer settlement agent services. Aside from this, they can also take care of your daily preparations of account statements and offer legal access to investment assets.
Additionally, prime brokerage can also offer access to various resources not many institutions have in-house.
Therefore, it’s safe to say that prime brokerage offers their clients – usually large institutions – all the necessary means to delegate and outsource a large portion of their investment activities.
This is extremely important as it allows these institutions (clients) to shift their attention to more important aspects of investing, such as defining their investment goals and focusing more on their investment strategies.
Other commonly offered services include risk management, securities financing, capital introduction and cash financing. Operational support and consulting are also oftentimes offered to clients, as well as margin financing and electronic trading.
Some prime brokers even offer various facility-based benefits, such as a chance to sub-lease an office space. Here, as well, the client can choose to make use of all of the options and services offered or simply opt for just some of them.
It’s also important to note that, in case a client is looking to borrow securities, the prime brokerage will require some collateral. This enables the brokerage to minimize potential risks and provides it with quick access to funds, if necessary.
Prime brokerage accounts requirements
Most of the prime brokerage clientele consists of large-scale institutions and investors. So, various professional investors, as well as arbitragers and hedge funds, are some of the most typical clients of prime brokers.
Particularly when hedge funds are concerned, the services offered by prime brokers – or the lack thereof – can easily make or break a fund’s success.
Two of the most common types of prime brokerage clients include pension funds and commercial banks. Here, pension funds have the role of an institutional investor.
Both of these clients usually deal with large amounts of assets that go into their investment efforts but often lack the internal resources that would allow them to take care of these investments on their own.
When it comes to opening and obtaining a prime brokerage account, financial institutions need to have a minimum account size. However, keep in mind that all prime brokers have their own fees and requirements.
Even though hiring the services of prime brokerage will require a hefty sum, these services are still extremely sought after.
It’s also worth mentioning that prime brokers will mostly look for clients they can also benefit from overtime, which is why they usually don’t offer their services to just about everyone.
Prime brokerage – most common questions
Now that we’ve defined the term, went over some of the most common prime brokerage services and discussed basic account requirements, it’s time to go over some of the most frequently asked questions that will also provide more insight.
- What is the main difference between a broker and a prime broker?
A broker is an entity or an individual hired by an investment account to simplify and assist with the process of buying or selling securities, such as stocks and bonds.
On the other hand, a prime broker is an institution that offers various additional services to other large institutions. These services include – but are not limited to – cash management, securities lending, risk management, etc.
- How much do prime brokers charge?
As mentioned earlier, all prime brokers will have their own prices and fees. The rates they charge will also vary from client to client, as well as the number of services they opt for, among other things.
- What is the margin in prime brokerage?
Margin, also known as margin financing, refers to the act of prime brokers lending money to a client, which they then use for purchasing securities.
Here, the prime broker will only have a risk regarding their client’s ability to make margin payments. Margin terms are, of course, determined beforehand and they directly affect the lending limits.
- What is a prime brokerage agreement?
Prime brokerage agreement refers to the agreement made between a prime broker and their clients. The agreement is there to determine which services the prime brokerage offers their clients and lay out the terms of such an agreement. These include fees, account requirements, transaction levels and all other relevant pieces of information.
- How does prime brokerage generate revenue?
Overall fees, commissions on transactions, as well as lending charges are all the ways in which prime brokerage generates revenue. Of course, these are not their only streams of revenue, but they are some of the most obvious ones.
Wrapping up
Any large institutions looking to streamline their business and outsource some of their activities that will allow them to focus on more important business matters can greatly benefit from hiring prime brokerage services.
Prime brokerage plays a huge part in the success of such large institutions, but it also provides numerous job opportunities for people, which makes a significant contribution to the overall economy.
So, for various clients, and particularly those who operate on a larger scale, hiring prime broker services will significantly streamline the majority of their business operations, enabling them to focus on growing their endeavors.
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