What Is a Prime Brokerage?

A prime brokerage is a bundled group of services that investment banks and other financial institutions offer to hedge funds and other large investment clients that need to be able to borrow securities or cash in order to engage in netting to achieve absolute returns.

The services provided under prime brokering include securities lending, leveraged trade execution, and cash management, among other things. Prime brokerage services are provided by most of the largest financial services firms, including Goldman Sachs, UBS, and Morgan Stanley, and the inception of units offering such services traces back to the 1980s.

Key Takeaways

  • Prime brokerage refers to a bundle of services that investment banks and other major financial institutions offer to hedge funds and similar clients.
  • Services included within a prime brokerage bundle may include cash management, securities lending, and more.
  • The services of a prime brokerage aid hedge funds in accessing research, finding new investors, borrowing securities or cash, and more.
  • A prime brokerage service gives large institutions a mechanism allowing them to outsource many of their investment activities and shift focus onto investment goals and strategy.
  • Financial institutions need a minimum account size to be able to transact with prime brokers and all prime brokers have different requirements and fees.
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Prime Brokerage

Understanding a Prime Brokerage

Prime brokerage services revolve around facilitating the multifaceted and active trading operations of large financial institutions, such as hedge funds. Central to their role, prime brokers allow hedge funds to borrow securities and increase their leverage, while also acting as an intermediary between hedge funds and counterparties such as pension funds and commercial banks.

Prime brokerages, at times referred to as prime brokers, are generally larger financial institutions that have dealings with other large institutions and hedge funds. The majority of large banks have prime brokerage units that service hundreds of clients. Though prime brokerages offer a large variety of services, a client is not required to take part in all of them and can have services performed by other institutions as they see fit.

Prime Brokerage Services

A prime brokerage offers a set of services to qualifying clients. The assigned broker, or brokers, may provide settlement agent services along with financing for leverage. Custody of assets may be offered, as well as daily preparations of account statements.

Prime brokers offer a level of resources many institutions may not be able to have in-house. In essence, a prime brokerage service gives large institutions a mechanism allowing them to outsource many of their investment activities and shift focus onto investment goals and strategy.

Concierge-style services may also be offered. These can include risk management, capital introduction, securities financing, and cash financing. Some go as far as to offer the opportunity to sublease office space and provide access to other facility-based benefits. As with more traditional offerings, participation in any of the concierge services is optional.

In cases of securities lending, collateral is often required by the prime brokerage. This allows it to minimize the risk it experiences as well as give it quicker access to funds if needed.

Requirements for Prime Brokerage Accounts

The majority of prime brokerage clients are made of large-scale investors and institutions. Money managers and hedge funds often meet the qualifications, as well as arbitrageurs and a variety of other professional investors. In the case of hedge funds, prime brokerage services are often considered significant in determining a fund's success.

Two common types of clients are pension funds, a form of institutional investor, and commercial banks. These forms of investors often deal with a large amount of cash for investment but do not have the internal resources to manage the investments on their own.

The minimum account size to open and obtain prime brokerage account services is $500,000 in equity, however, such an account is unlikely to get many benefits over and above what would be offered by discount brokers.

Some of the largest prime brokers in the U.S. are investment banks, including Bank of America, J.P. Morgan, Goldman Sachs, and Citigroup.

For hedge funds or other institutional clients to get the kind of services that make having a prime brokerage account worthwhile (most notably discounted fees for trading), an account size of $50 million in equity is a likely starting point.

Even so, these services are highly sought after by clients and the best banks only accept the clients that are most likely to be beneficial to them over time. For this reason, a hedge fund would probably need to have as much as $200 million in equity in order to qualify for the best treatment.

Example of a Prime Brokerage

Hedge Fund ABC just launched with $75 million that it raised from investors. It is a small hedge fund that employs 15 people. The majority of these individuals are traders, researchers, and a few administrative people. The fund has limited resources that it can allocate to the various needs that are required of the business.

To alleviate some of the burdens, ABC transacts with J.P. Morgan's prime brokerage unit. The two entities sign a prime brokerage agreement detailing that J.P. Morgan will assume the responsibilities of managing ABC's cash management, calculating its net asset value (NAV) on a monthly basis, and performing a risk management analysis on its portfolio. For these services, it is agreed that J.P. Morgan will charge a monthly fee of $20,000.

After six months, ABC has grown and its investment strategy has become more complex. It needs to borrow securities as part of its investment strategy and transacts with J.P. Morgan to provide securities lending services. For this, J.P. charges 5% on the amount of money borrowed. ABC also engages with J.P. for capital introduction services, whereby J.P. introduces ABC to potential investors, charging 2% of the invested amount by each investor.

All of these services that J.P. provides to hedge fund ABC constitute prime brokerage services.

Prime Brokerage FAQs

What Is the Difference Between a Broker and Prime Broker?

A broker is an individual or entity that facilitates the purchase or sale of securities, such as the buying or selling of stocks and bonds for an investment account. A prime broker is a large institution that provides a multitude of services, from cash management to securities lending to risk management for other large institutions.

How Much Do Prime Brokers Charge?

Prime brokers charge different rates for different clients. And each prime broker has its own fees. They also charge different rates depending on the volume of transactions a client does, the number of services a client uses, and so on.

What Is Margin in Prime Brokerage?

Margin is when a prime broker lends money to a client so that they can purchase securities. It is also known as margin financing. The prime broker has no risk on the underlying positions, only on the ability of the client to make margin payments. Margin terms are also agreed upon beforehand to determine any lending limits.

What Is a Prime Brokerage Agreement?

A prime brokerage agreement is an agreement between a prime broker and its client that stipulates all of the services that the prime broker will be contracted for. It will also lay out all the terms, including fees, minimum account requirements, minimum transaction levels, and any other details needed between the two entities.

How Does a Prime Brokerage Generate Revenue?

A prime brokerage generates revenue in a few different ways, which include overall fees, commissions on transactions, and lending charges.

The Bottom Line

Prime brokerage is an important service that is provided to large institutions to help them facilitate their business and outsource activities that allow them to focus on their core responsibilities.

Prime brokerage is an important part of the financial sector that creates jobs for thousands of peoples and contributes significantly to the economy. For many large institutions, a prime broker can be a one-stop-shop that makes doing business much easier.