What is Prime Brokerage ?
History of Prime Brokerage
The growth in the number of hedge funds as well as the scale of their operations quickly created the need for a special kind of intermediary that would cater to their needs. This intermediary was the prime broker. The prime brokerage business quickly caught the attention of many investment banks as it became a significant source of revenue.
Today all major investment banks have a prime brokerage business and it forms a significant chunk of their revenues. Also, hedge funds are almost the only clients that prime brokerages have. An increase in the number of prime brokerage firms while the number of hedge funds has remained constant has caused intense competition in the industry.
Prime brokerages evolved from the ever increasing scale of hedge fund operations. As hedge funds started trading regularly, their operations became complex and difficult to manage. The technology and infrastructure required to manage these operations was expensive and since it was not a part of the hedge funds core business, it was not a worthwhile investment.
However, major investment banks already had the infrastructure in place to manage investments worth billions of dollars. They would therefore provide this service to the hedge funds in return for a fee. The services provided were many and varied. It is for this reason that it has been difficult to come to a precise definition of what constitutes a prime brokerage firm. Some of the services provided by prime brokerage firms are mentioned below.
Services Provided By Prime Brokerage
Since prime brokerages provide these generic services, there is a lot of competition amongst them. This competition is benefitting the hedge fund industry. Many prime brokers go as far as providing some sort of seed fund for the hedge fund to lure a hedge fund to take up their services.
The prime brokerage industry is virtually unregulated across the world. However, in the United States there is some amount of regulation. For instance, a prime broker cannot open an account unless there is at least $500000 in equity in the case of an individual or $1000000 in equity in case of an organization. Ambiguity arises when prime brokerages based out of United States fund operations within the United States. The regulation is not quite strong enough and market participants are able to find quite a few loopholes.
Financial market participants are averse to any kind of regulation. This has caused a lot of hedge funds to shift their businesses to offshore locations. For instance, Morgan Stanley has been amongst the first firm to start an international prime brokerage desk at its London office.
Wall Street therefore is not the hub of prime brokerage activity. Instead, such activities are concentrated in locations like Singapore and London.
Selecting a Prime Broker
Hedge funds are rightly very picky when it comes to selecting their prime broker. A prime broker is not just a vendor. Instead, they are business partners and their action or inaction can have grave consequences.
A lot of other factors go into selecting a prime brokerage. Since prime brokerages literally run the operations of these hedge funds, it is essential to understand in order to understand the hedge fund business.
Authorship/Referencing - About the Author(s)
The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.