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[[Prime broker]]s often also have a consulting arm which helps a nascent {{tag|hedge fund}}s get off the ground: setting it up, finding offices, hiring people, engaging lawyers, recommending (cough) [[prime broker]]s, and [[capital introduction]]. | [[Prime broker]]s often also have a consulting arm which helps a nascent {{tag|hedge fund}}s get off the ground: setting it up, finding offices, hiring people, engaging lawyers, recommending (cough) [[prime broker]]s, and [[capital introduction]]. | ||
==Why [[prime broker]]s do it== | |||
'''[[Prime brokerage]] is a ''financing'' business'''. This is the key to it: ''to [[lend]] clients [[money]]'' so they can make investments. All going well the client keeps all the profits and losses from their investments, but pays the PB interest and repays [[principal]]. Client lets the PB look after the assets so it can monetise them, thereby lowering its costs of providing the funding in the first place. | '''[[Prime brokerage]] is a ''financing'' business'''. This is the key to it: ''to [[lend]] clients [[money]]'' so they can make investments. All going well the client keeps all the profits and losses from their investments, but pays the PB interest and repays [[principal]]. Client lets the PB look after the assets so it can monetise them, thereby lowering its costs of providing the funding in the first place. | ||
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*'''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. | *'''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 {{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) | ||
*'''Act as {{aifmdprov|depositary}}''': [[PB]]s, which tend to be situated in London, or New York, generally cannot act an official {{aifmdprov|depositary}} for {{tag|AIFMD}} purposes (though they may get delegated the safekeeping role and may act as a {{aifmdprov|depo-lite}}) | *'''Act as {{aifmdprov|depositary}}''': [[PB]]s, which tend to be situated in London, or New York, generally cannot act an official {{aifmdprov|depositary}} for {{tag|AIFMD}} purposes (though they may get delegated the safekeeping role and may act as a {{aifmdprov|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) | *'''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 | ==Prime broker solvency== | ||
Cue thundercrack — the [[Lehman]] insolvency was a chastening experience for some [[hedge fund]]s who discovered to their dismay that their assets — which they thought [[Lehman]] was holding safely in a little shoebox under its bed for them — were rather harder to get back than they expected. They hadn’t gone awol as such, but were somewhat caught in the gears of the great steampunk machine. | |||
The financial crisis has led to a good deal of focus from both clients and regulators on bank solvency, but fifteen years on the world is a very different place, and our view — coloured by a decade advising prime brokers, granted but still — is that prime brokerage customers should spend a little time managing the extreme tail risk of their prime broker failing during their relationship, and less time obsessing about it in the abstract when they negotiate their master agreements because, frankly, it is all rather tiresome. | |||
It works like this: a customer can unwind its positions, repay its lending and withdraw its assets ''at will on any day''. As long as the prime broker has been paid, it will just give you back your assets, or, at your choice, their money’s worth. Now seeing as fully capitalised regulated financial institutions do not typically collapse over night — [[Lehman]] was fast, and it was teetering on the brink for months — its final slide was fairly constant and took about seven months — if you are half-way paying attention there is plenty of time to get your assets out before corkscrewing into a ditch. Hedge fund advisors are meant to understand the equity market. Look at the equity of your [[prime broker]]!<ref>By contrast, the collapse of [[hedge fund]]s ''can'' be very fast. See our old friend [[Archegos]]. And [[LTCM]], and [[Amaranth]], and [[Madoff]]... [''All right, you have made your point. Ed'']</ref> | |||
Since 2008 the FCA has significantly tightened its CASS custody rules, in particular introducing a rule obliging prime brokers to cover any custody shortfall with their own assets, and enhancing customer asset segregation rules. And the worlds financial regulators have introduced broadly similar bail-in and bank resolution regimes, meaning the resolution of failing banks will be a much more managed process than it used to be, with the main goal of protecting the overall financial system from the shock of the failure of a significant credit institution. | |||
Should you be asleep at the switch and miss the pending implosion of your prime broker, then the solvency regime of your prime broker isn’t really the thing that makes recovering your assets hard. It will be (i) unwinding any [[reuse]]/[[rehypothecation]] arrangements and (ii) satisfying outstanding indebtedness and releasing any security interests over the assets. Neither of these things are a function of the insolvency regime of the broker. | |||
Under an English law [[reuse]] arrangement, a prime brokerage customer is an [[unsecured creditor]] of the [[prime broker]] for the return of [[equivalent]] reused assets. To the extent that the return obligation is offset by the customer’s liability under its margin loan portfolio, this is a zero-sum game, but generally the reuse multiplier will be more than 100% and may be as much as 140%. For this balance, the customer has prime broker credit risk. (This is not ''necessary'' true under a US [[rehypothecation]] arrangement, because under one of those typically alchemical US legal constructs, the prime brokerage customer retains ownership of a rehypothecated asset even while the prime broker sells it outright into the market, so at least inside the PB’s books and records the customer has a preferred claim to the rehypothecated asset over other creditors of the bank. What this means in practice may be quite different (to what a US customer expects, and quite similar to what an English one would get). | |||
Even if you recover all the reused assets and return them to the prime brokerage custody account, there is another obstacle: the security interest. This is likely to delay return of your asset, because the banks administrator will want to make sure that every conceivable debt claim for which the assets are security is recovered first — or applied against the assets — before any security is released. and here the “kitchen-sink” security model that all [[prime broker]]s use will gum things up. For prime brokers take security against not just close-out liabilities due under identified maser agreements, but, you know, “any [[indebtedness]], claim, [[liability]], [[Damages|damage]] or [[loss]], present or future, direct or indirect, [[Contingent liability|contingent]] or otherwise, that Client or Client’s [[affiliates]], friends or relations, jointly or severally, may owe to [[prime broker|Prime Broker]], its [[affiliates]] and any of its employees, officers directors, agents or advisors however described”. Right? | |||
==Not to be confused with== | |||
*[[broker/dealer]] | *[[broker/dealer]] | ||
*{{aimfdprov|Depositary}} | *{{aimfdprov|Depositary}} | ||