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Prime Brokerage

A financial institution that acts on behalf of the client to complete the latter's investment transactions

What is Prime Brokerage?

Prime brokerage is a set of services offered by investment banks and other large financial institutions to hedge funds and other investment clients. The clients need such services when borrowing securities or cash for the purpose of netting to allow a specific asset to achieve a higher return.

 

Prime Brokerage
Fig. 1: What is Prime Brokerage?

 

Summary

  • Prime brokerage is a set of services offered by large financial institutions to investment clients.
  • As a prime broker, the financial institution acts on behalf of the client to complete investment transactions for the client.
  • A brokerage offers a variety of services, operating in all parts of the financial markets.

 

What is Netting?

Netting is a process where multiple positions are taken on by an investment bank or financial institution and can be aggregated into one net obligation position. This is done to reduce the risk in multiple financial contracts that are taken on by investment institutions.

 

Prime Brokerage Providers

Prime broker is the classification for those that provide prime brokerage services, and they tend to be the larger financial institutions. A selection from around the world is shown in the list below. They are considered the leading players in the financial industry as they serve the largest investment clients.

 

Selection of Financial Institutions with Prime Brokerage Units

  • Royal Bank of Canada
  • Bank of Montreal
  • TD Bank
  • Goldman Sachs
  • JP Morgan Chase
  • Deutsche Bank
  • HSBC
  • Barclays
  • Citi
  • Nomura

 

Services Provided by Prime Brokers

 

Prime Brokerage Services
Fig. 2: Prime Brokerage Services

 

1. Securities Lending

Securities lending includes all types of securities available in the financial industry. A security loaned to a borrower means the title and ownership are transferred over.

A loan fee is charged by the brokerage for this service. The total cost includes both the fee for borrowing and any interest that is agreed upon as per the contract. Security holders who allow borrowers to use their security to short the stock receive a rebate from a prime broker.

 

2. Cash Management

Cash management is the process of collecting and managing the cash flows of individuals and businesses. A financial institution that serves as a prime broker only works with large institutional investment companies. Effective management of cash is very important to the business and its stability.

 

3. Custody Services

A prime brokerage provider works as a global custodian. A custodian refers to a financial institution that holds securities of its clients for safekeeping.

The custodian can hold stocks or other types of securities in both electronic and physical forms. Usually, the custodians hold securities of high value; therefore, they tend to be large reputable firms like prime brokerages.

 

4. Leveraged Transaction Execution

A leveraged transaction is where the institution borrows funds to complete a transaction. At the institution where prime brokers work, the transaction involves a significant amount of money if they provide leverage and if the broker is also taking the role of a clearing agent.

 

5. Settlement Services

A prime broker offers clearing services for transactions in both cash and securities. Clearing is ensuring the transaction settles with a timely transfer of funds and shares to both parties. It is a complex process and requires a specialized organization to act as a middleman to ensure transactions are settled properly.

 

Prime Brokerage in the Real World

XYZ is an investment firm with $100 million generated from its clients. It is a relatively small hedge fund personnel-wise and lacks the expertise to best allocate and invest the funds.

The investment firm contacts the prime brokerage team at Goldman Sachs, and they sign an agreement for the latter to be their prime broker. As the prime broker, Goldman Sachs offers XYZ several services, including cash management, NAV calculation on a regular basis (i.e., weekly, monthly, quarterly, etc.), and risk management services. It can also offer other services that prime brokerage offers as and when needed.

The continued growth and expansion of XYZ’s hedge fund business mean the client would like to enter the more complex parts of the financial markets. The hedge fund could enter the financial securities market either through the lending of securities or leveraged transaction execution. Simply put, XYZ may require the clearing capabilities of their broker.

 

To learn more about Prime Brokerage, check out CFI’s Prime Services and Securities Lending course!

 

Additional Resources

Thank you for reading CFI’s guide to Prime Brokerage. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

  • Clearing House
  • Financial Intermediary
  • Highly Leveraged Transaction (HLT)
  • Netting