Reporting: The large and varied portfolio of hedge funds warrants the use of a specialist to track the positions and provide data to the decision makers. The speed and accuracy of this data is crucial since decisions need to be made really quickly. Once again investment banks have the infrastructure to provide such services and allow their prime brokerage units to use it to provide a value added service in order to retain the client.
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.
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. The role served by a prime brokerage is that of facilitating large, active trading operations such as hedge funds.
A prime broker can be thought of as a sort of central broker, facilitating and coordinating extensive, complex trading in a variety of financial instruments. Prime brokerage services are provided to institutional clients by major investment banks such as Merrill Lynch and Goldman Sachs. Prime brokers provide a wide variety of custodial and financial services to their hedge fund clients, including acting as an intermediary between hedge funds and two key counterparties. The first of these important counterparties are large institutional investors , such as pension funds, that have massive equity holdings and, therefore, serve as a source of securities to lend for short-selling purposes.
The second group of important counterparties is commercial banks that have adequate funds available to make large loans for margin purposes. These two counterparties, with the aid of the prime brokerage, enable hedge funds to engage in large-scale short selling through borrowing stocks and bonds from the large institutional investors, and to maximize their investments through leverage by obtaining margin financing from commercial banks.
The prime brokerage makes money by charging a fee, such as a spread or premium on the loan from a commercial bank, in return for facilitating the transaction. Another core service provided by prime brokers is that of trade clearing and settlement. While a hedge fund traditionally operates through accounts at a number of brokerage firms, it commonly instructs these executing brokers to clear all trades through its designated prime broker.
This simplifies reporting and operations for the hedge fund since the prime broker also typically serves as the custodian for the hedge fund's assets. It further simplifies and streamlines the process of borrowing investment securities and capital since the hedge fund's assets can quickly and easily be shifted to the prime broker as collateral. What is the difference between a broker and a prime broker? A broker facilitates the trading of securities, such as the buying or selling of stocks for an investment account.
A prime broker, instead, is a large institution that provides a multitude of services, from cash management to securities lending to risk management for other large institutions. In addition to the core lending services they provide, prime brokers offer their hedge fund clients other services, sometimes referred to as "concierge services," designed to ease and enhance the operation of a hedge fund.
One important additional service is offering risk and performance analytics. A number of prime brokers have partnerships or other arrangements with risk management service providers, such as RiskMetrics Group, that enable them to provide hedge fund clients with daily risk and performance analysis services. Another important service is capital introduction for the fund manager. Capital introduction is essentially the process of connecting hedge fund managers to potential investors in the form of the prime broker's asset management and private banking clients.
Prime brokers further serve their hedge fund clients, who frequently engage in trading derivative financial instruments, by offering them access to their derivatives trading desks, along with risk management suggestions from their own derivatives trading operations. Prime brokers also typically offer their hedge fund clients private access to the prime broker's research services, thus enhancing and reducing research costs for the hedge fund.
What is the definition of prime brokerage? Prime brokerage involves services such as securities lending, risk management, cash management , leverage buyouts , and more, which are offered to qualified customers, i. A brokerage firm may also provide leveraged financing and custodian services to individual investors. What's more, prime brokers can use the collateral from clients for their own investments.
This is known as rehypothecation. In many cases, the fund partners permit their collateral to be used this way in exchange for a reduction in fees. Rehypothecation comes with some risk to the investor. There is always a chance the brokerage could lose the investment even though it never owned it in the first place. The practice of hypothecation was much more common prior to the collapse of the financial sector in and Federal Reserve Bank of St. Accessed Dec. Actively scan device characteristics for identification.
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