Definition of prime broker account
Prime broker account, commonly an investment company or large bank, provides a variety of services to hedge funds relating to operational support, clearing, risk management and settlement of transactions. Moreover, an operational office, a trading office, brokerage company or a managing company that helps to resolve various tasks are also termed as a prime broker account.
The prime broker acts as an intermediary between a hedge fund and two counterparties ( the first being large investors and the second the commercial banks). The prime broker account enables hedge funds to borrow bonds and stocks from large investors to engage in large scale short selling.
Moreover, they maximize hedge fund investments through leverage by receiving margins from commercial banks. Also, the prime broker makes money by fee like in return for providing a transaction, they obtain a premium on the loan from commercial banks(noted in prime brokerage accounting) or rehypothecation.
Role of a Prime Broker
Prime broker account has a role to facilitate investment on behalf of a hedge fund with capital borrowed against the hedge fund. Prime broker accounts enable greater visibility on performance as all are settled via a prime broker. As a result, their responsibilities depend upon what is right for clients and the hedge fund. Responsibilities of a prime broker account include the following:
- Client services
- Clearing and give up services
- Risk management and financing
- Capital introduction
- Hedge fund consulting services
- Bank credit lines
- Online and voice trade execution
- Reporting and portfolio technology
- Research and market timing advice
- Securities lending
Prime broker accounts do not charge fees for package bundled services that they provide to hedge funds. As a result, revenues are derived from three sources i.e trading commissions, spreads on financing including the stock loan and fees for the settlement of transactions operated away from the prime broker account.
The lending and financing spreads, charged in basis points on the value of client deposits(credit balances), client loans(debit balances), synthetic financings products like CFDs(contract of difference) or swaps and client short sales(short balances) holds a large majority of prime broker account revenue.
Moreover, it must be noted that clients who choose short selling or leverage showcase more lucrative opportunities than the clients who undertake less short selling or utilize minimum leverage.
As a result, the clients having fixed income-oriented market activities produce less prime broker account revenue. However, they might present economic opportunity in the foreign exchange futures, repo and flow business areas of an investment bank.
Services by Prime Broker Account
Although the services under prime brokerage accounting are provided by the prime broker themselves with no difference. But there can be other services as well;
The prime broker virtually provides access to an unlimited pool of money for reasonable interest rates at short notice. The leverage ratios can commonly reach 10:1 while the prime broker account comfortably provides these risk management services at reasonable fees.
The hedge funds have high open positions where assets can be replaced frequently. As a result, the clearing and settlement procedure of the trades needs to be precise and efficient for which the hedge funds do not have an infrastructure. Therefore, the prime broker account (prime brokerage accounting) enters into the image and provides value-added services.
The varied and large portfolios of hedge funds need specialists to provide information to the decision-makers. Along with this, there needs to be accuracy and speed since the decisions are made quickly. As a result, the prime broker account helps with reporting and retaining their client.
Online and trade execution:
Prime broker account experience dealers for managing online trade with more complex order brokerage services. they provide clients with dedicated lines an online trading platform as well as the facility over the phones to execute orders(voice dealing).
Clearing gives up services:
Prime broker clients may spread across multiple execution brokers and trade through small brokers, then they have to give up to the main clearing prime broker account to exercise execution anonymity.
When traders and hedge funds hold short positions, the underlying shares are required to be borrowed. As a result, prime broker account securities lending departments enables clients to directly borrow from the prime broker account. It is done to reduce the risk of holding a long term short-position and financing costs.
Prime broker account has a client services department for back-offline support to handle clearing issues, general account management and complex corporate actions.
Risk management and financing:
Clients could manage cross-exchange positions with SPAN margin facilities to ensure minimum margin requirements on offset positions and hedged funds with portfolio risk management.
Reporting and portfolio technology:
A hedge fund might outsource regulatory processes and compliance needed to run a hedge fund to its prime broker account through risk management technology and consultancy services.
Prime brokers’ main value is their network of clients. As a result, hedge funds take advantage of their network to generate new business, increase visibility and inflow of capital.
Selection of a prime broker
A prime broker account not only plays the role of a vendor because of which the hedge fund becomes choosy while its selection. They are business partners whose inaction or actions can lead to great consequences.
- Hedge funds note the prime broker access to end technologies because the hedge fund does not have a back office on its own.
- The prime broker financial position is also verified. This step becomes important since hedge funds do not want to miss trades due to the broker’s cash strap or inability to finance them at a moment’s notice.
- The prime broker account offering the highest loan to a hedge fund to value ratios are preferred. This states that prime brokers on minimum collateral can give out maximum loans to hedge funds.
However, there are other factors also which count in the selection of prime brokers(under prime brokerage accounting) but the major and corresponding to hedge funds are mentioned above.
Risks of Prime Broker Account
The activity of the prime broker account facilitates hedge funds leverage basically through loans secured from the long positions of his clients. In context to this, a prime broker account is exposed to the risk of loss when the value of collateral as security lies below the loan value and the client is unable to pay the deficit. Other risks can be a reputational and operational risk.
The prime broker account monitors the risk in client portfolios via house-designed risk-based margin methods that count the worst case loss for a portfolio. This might be based on the concentration, liquidity, macro-economic, ownership, other risks and investing strategies of the portfolio.
Liquidity penalties might get established using the rule of thumb for days to liquidate ( when 10% of the trading volume can be liquidated ) without overdue influence on the price. Therefore, 10 business days would be assumed to liquidate a daily trading position.
The what-if scenarios can entail through stress testing that finds theoretical losses and profits in each position due to adverse market conditions.
Examples of stress test scenarios can be 3-15% up or down in price movements of portfolio margin and flight to quality.
Prime Brokers List
Prime broker account can be split by asset and size class. The large prime broker account only accepts large clients. As a result, start-up and smaller hedge funds, traders and brokers should use a specific type of prime brokers list appropriate to their kind of trading which are as follows:
Mini Prime Broker
Firstly discussing from the prime brokers list, mini brokers accept small institutional accounts. This kind is useful for start-up and new hedge funds. A client can switch to a mini prime brokers list that offers the type of investment that the investor needs for the hedge fund.
Boutique Prime Broker
Prime brokers list, for the second category, provide reading infrastructure and operational framework for start-up or small hedge funds that become too small for tier 1 prime broker account. They have direct relationships with large prime brokers and resell service on a wholesale basis to their clients.
Start-up hedge funds
The top tier prime brokers list might shut down all their smaller accounts. As a result, start-up hedge funds need a mini broker or mid-tier prime broker account. Therefore, the prime broker finder tool helps to find the top prime broker list for the client’s investment strategy.
Small hedge funds
There is a best prime broker list for small to medium-sized hedge funds that assist the client’s trading and fund strategy. It includes regulatory umbrellas, analysis, outsourced back-office systems, custodian services, and research.
Prime of prime brokers
Prime of prime broker account explains retail brokers with market access. This concept is common with forex platforms and CFD. Where the prime broker provides the platform, administration of accounts and liquidity back office. Also, forex brokers act as marketing matching.
Comparisons of different brokers
Prime broker vs Executing broker
In the concept of prime broker vs executing broker, the executing broker deal with large institutional clients. This kind of broker submits the order on behalf of the client. In brief, it takes care of trading, carrying out the order. The hedge fund managers work with the prime brokerage house as prime broker account.
That offers to consolidate services whereas executing brokers buy or sell with the prime broker. Executing brokers earn from commissions or conflict of interest that occur from time to time. Therefore in prime broker vs executing broker, where the prime broker deals with trading. On the other hand, executing ones for clearing.
Prime Broker vs Custodian
In the case of prime broker vs custodian, also termed as custody provider. It keeps possession of the assets according to pilotage. It acts as a safe box to which only prime broker has access but only with the client’s express consent.
At the time when stock certificates prints on paper, the custodians used to store them. However, today almost everything is stored and handles electronically. When the client sells a stock, for prime broker vs custodian transfers electronic entry depicting stock certificates to the buyer account. Also, accepts cash on the client behalf from the seller.
Prime broker vs Clearing broker
In respect of prime broker vs clearing broker, a clearing broker refers to as a member of an exchange that acts as a liaison between clearing corporation and investor. This kind of broker helps to ensure that transaction is successful and trade settles appropriately.
They are furthermore responsible for maintaining paperwork which connects with executing and clearing transaction. Counting prime broker vs clearing broker, they ensure that securities market rune efficiently.
They handle buy or sell orders whereas also maintain custody of account owners assets. This notes that apart from clearing brokers, no other type from prime broker account has the authority to clear transactions.
Prime broker vs Retail broker
Comparing prime broker vs retail broker, a retail broker facilitates debt and equity trades for their clients(including bonds and stocks). They might also sell financial products and additional securities like limited partnerships, real estate investment trusts, mutual funds and options.
The retail brokers may also advise clients on tax-advantaged products, individual retirement accounts, managing their assets or planning for children’s education. It notes in prime broker vs retail broker that retail brokerage firms do not possess in-house investment banking capabilities. They can refer investment banking prospects and lead to mid-market securities.
Prime broker vs broker
Comparing prime broker v/s broker, the broker is an independent party who serve different industries. Their key responsibility is to bring buyers and sellers together where the broker acts as a third-person facilitator between them.
An example can be a stockbroker and real estate who facilitates the sale of the property. They can furnish market data and research. In prime broker v/s broker, he expects to have resources and tools to reach the largest possible base of sellers and buyers.
Then they screen this potential research for a perfect match. Moreover, an individual producer will not have access to customers as the brokers do. Another benefit that counts is that they are cheaper in smaller markets. Also, with a limited line of products and smaller accounts.