Prime broker: Difference between revisions
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===Why [[prime broker]]s do it=== | ===Why [[prime broker]]s do it=== | ||
[[Prime brokerage]] is a ''financing'' business. This is the key to it: ''to [[lend]] your clients [[money]] so they can make investments. All going well the client keeps all the profits and losses from their investments, but pays you interest and repays your principal''. | '''[[Prime brokerage]] is a ''financing'' business'''. This is the key to it: ''to [[lend]] your clients [[money]] so they can make investments. All going well the client keeps all the profits and losses from their investments, but pays you interest and repays your [[principal]]''. | ||
You can lend them [[money]] — ''explicitly'', through [[cash]] [[margin loan]]s, or ''implicitly'' through [[equity derivative]]s, and you can [[Securities lending|lend them securities]] so they can short-sell (also explicitly, through an outright [[stock loan]] or implicitly through [[equity derivative]]s). All this so your fund can generate — ahh — “[[alpha]]”<ref>Editor’s note: actually ''“[[vega]]”''.</ref> | You can lend them [[money]] — ''explicitly'', through [[cash]] [[margin loan]]s, or ''implicitly'' through [[equity derivative]]s, and you can [[Securities lending|lend them securities]] so they can short-sell (also explicitly, through an outright [[stock loan]] or implicitly through [[equity derivative]]s). All this so your fund can generate — ahh — “[[alpha]]”<ref>Editor’s note: actually ''“[[vega]]”''.</ref> | ||
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You make your money charging a financing rate to your clients on the money you lend them. the challenge is that your business will have to ''pay'' a financing rate, to your treasury department, for all the cash you are using in your business to lend to your customers. The trick is to organise your operation be as efficient as possible, to reduce that cost the treasury department charges you. The lower your cost of funding, the better your margins. | You make your money charging a financing rate to your clients on the money you lend them. the challenge is that your business will have to ''pay'' a financing rate, to your treasury department, for all the cash you are using in your business to lend to your customers. The trick is to organise your operation be as efficient as possible, to reduce that cost the treasury department charges you. The lower your cost of funding, the better your margins. | ||
How do you improve your cost of funding? By taking the | '''[[Margin lending]]''': How do you improve your cost of funding? By taking the shares you hold in your PB business (either your clients’ [[custody asset]]s, where they are buying the shares outright — this is called “[[cash prime brokerage]]” — or the [[shares]] you buy to [[hedge|hedges]] the [[equity derivatives]] you write to your clients, where they are taking only economic [[exposure]] to [[shares]] under a [[swap]] and are not buying them outright — this is called “[[synthetic prime brokerage]]” — and in either case converting those shares back into [[cash]], or cash-like instruments, that you can use to pay down what you have borrowed from your own [[treasury department]]. | ||
So remember these two things: | |||
*'''Prime brokers are not the other side of the trade to their clients'''. Even on equity swaps. ''They are on the same side.'' All they care about is getting their loans paid back with interest/. The better their clients’s investment returns, the safer is their lending position. | |||
*'''Prime brokerage is margin lending''': The reason the [[prime broker]] wants your assets is not just for [[security]], but so it can use them to reduce its own internal cost of funding. The lower its own cost of funding, the less it has to charge you. So it is in your interest to let the prime broker reuse your assets, if you are allowed to. | |||
===What prime brokers don’t do=== | ===What prime brokers don’t do=== | ||
*'''Act as {{tag|PB administrator}}''': While they look after assets, prime brokers don’t calculate {{tag|NAV}} (that’s the {{tag|PB administrator}}’s job) | *'''Act as {{tag|PB administrator}}''': While they look after assets, prime brokers don’t calculate {{tag|NAV}} (that’s the {{tag|PB administrator}}’s job) | ||
Revision as of 14:03, 22 January 2020
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Prime Brokerage Anatomy™
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Brokerage Anatomy™
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This article is largely about equity prime brokerage, because that’s mainly what the JC knows about.
A prime broker is the business division of an investment bank that looks after hedge funds.
What prime brokers do
Prime brokers — fondly known in the trade as PBs — provide the following services:
- Custody: looking after the hedge fund’s “long” investment portfolio - (but this is because they like to reuse all those lovely assets)
- Bank accounts: running a multi-currency cash account - from which they can lend money.
- Margin lending: lending on margin to hedge funds who want to own securities without paying for them (you know - leverage).
- Stock lending: lending the hedge fund the assets it needs to settle short sales, and lending it the money it needs to buy assets.
- Synthetic prime brokerage: providing the hedge fund with derivative exposure to assets as an alternative to the hedge fund buying them outright). Often in the trade called “CFD”s. This may involve accepting give-ups from other executing brokers.
- Swaps and ETD: Providing general exposure to swaps, futures, options and that sort of thing.
Prime brokers often also have a consulting arm which helps a nascent hedge funds get off the ground: setting it up, finding offices, hiring people, engaging lawyers, recommending (cough) prime brokers, and capital introduction.
Why prime brokers do it
Prime brokerage is a financing business. This is the key to it: to lend your clients money so they can make investments. All going well the client keeps all the profits and losses from their investments, but pays you interest and repays your principal.
You can lend them money — explicitly, through cash margin loans, or implicitly through equity derivatives, and you can lend them securities so they can short-sell (also explicitly, through an outright stock loan or implicitly through equity derivatives). All this so your fund can generate — ahh — “alpha”[1]
You make your money charging a financing rate to your clients on the money you lend them. the challenge is that your business will have to pay a financing rate, to your treasury department, for all the cash you are using in your business to lend to your customers. The trick is to organise your operation be as efficient as possible, to reduce that cost the treasury department charges you. The lower your cost of funding, the better your margins.
Margin lending: How do you improve your cost of funding? By taking the shares you hold in your PB business (either your clients’ custody assets, where they are buying the shares outright — this is called “cash prime brokerage” — or the shares you buy to hedges the equity derivatives you write to your clients, where they are taking only economic exposure to shares under a swap and are not buying them outright — this is called “synthetic prime brokerage” — and in either case converting those shares back into cash, or cash-like instruments, that you can use to pay down what you have borrowed from your own treasury department.
So remember these two things:
- Prime brokers are not the other side of the trade to their clients. Even on equity swaps. They are on the same side. All they care about is getting their loans paid back with interest/. The better their clients’s investment returns, the safer is their lending position.
- Prime brokerage is margin lending: The reason the prime broker wants your assets is not just for security, but so it can use them to reduce its own internal cost of funding. The lower its own cost of funding, the less it has to charge you. So it is in your interest to let the prime broker reuse your assets, if you are allowed to.
What prime brokers don’t do
- Act as PB administrator: While they look after assets, prime brokers don’t calculate NAV (that’s the PB administrator’s job)
- Act as depositary: PBs, which tend to be situated in London, or New York, generally cannot act an official depositary for AIFMD purposes (though they may get delegated the safekeeping role and may act as a depo-lite)
- Act as an executing broker: They don’t themselves work equity orders for their clients (though their compadres across the Chinese wall in the equities trading division at the same investment bank almost certainly will)
Not to be confused with
See especially in the context of AIFMD: Prime broker - AIFMD Provision.