Synthetic prime brokerage

Equity Derivatives Anatomy™ →Go uptown {{{2}}} Resources About the Equity Derivatives Definitions | (full wikitext) | (nutshell wikitext) | Equity v credit derivatives showdown Hot topics Synthetic Prime Brokerage Anatomy | The Triple Cocktail | Cancellation and Payment | Calculation Agent TOC | 1 General Definitions | 2 Option Transactions | 3 Exercise of Options | 4 Forward Transactions | 5 Equity Swap Transactions | 6 Valuation | 7 Settlement | 8 Cash Settlement | 9 Physical Settlement | 10 Dividends | 11 Adjustments and Modifications | 12 Extraordinary Events · 12.8 Cancellation Amount · 12.9 Additional Disruption Events · 12.9 List of ADEs · 12.9(b) Consequences of ADEs | 13 Miscellaneous Index: Click ᐅ to expand: Equity Derivatives - Premium Synthetic Prime Brokerage Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

Prime brokerage done with derivatives. So :

• Going long: instead of buying shares on margin and asking your prime broker to hold them for you, you just trade a total return swap with your prime broker where the PB pays the return of the share price and you pay a floating rate. The PB will buy the physical shares and hold them in its own inventory as a delta-one hedge. But note it will do this across its whole book, not client-by-client, much less position-by-position.You will be exposed to the price of the assets, but will not have any control or ownership over the prime broker's hedge. This can sometimes lead to disappointment when it comes to voting and corporate actions, but it's all for the best.

• Going short: instead of borrowing shares from your PB and selling them short in the market, you just trade a total return swap with your PB, where you pay the return of the share price and the PB pays you a floating rate. Your PB will borrow the shares and sell them short in the market, and will pass on the cost of the borrow to you (by deducting it from the floating rate).

• Terminating: In the same way you can buy or sell a physical position on any day, under synthetic PB you can terminate a synthetic position on any day, at market (subject to usual market disruption and hedging disruption provisions (for more on this see our old friend the triple cocktail). Thus you can make your prime broker liquidate its hedge, but you can’t make it to sell the hedge to you or any of your friends and relations (something it might not want to do if it has an investment banking relationship with the issuer and you are an activist hedge fund).

• Tax Risk: In some jurisdictions, derivatives are taxed differently to equities (as regards stamp duty reserve tax for example) so it is important that your synthetic position doesn’t look like a tax play. One of the key ways it might do this is if you have contractual control over your prime broker’s hedge (in which case your swap position might be recharacterised as a disguised custody arrangement. Depending on which tax specialist you ask, this might extend even to the hedge execution price. Thus you will see much chatter about the termination price being the one a “hypothetical broker-dealer” might achieve selling fungible securities, and volume-weighted average prices and so on.