Prime Brokerage

Prime brokerage is a bundle of services that large banks and brokers provide to hedge funds and other professional investors. A prime broker lends the fund money, finds shares for it to short, clears and settles its trades executed with many brokers, holds its assets and gives it consolidated reports. For a hedge fund, the prime broker is a central partner that makes leverage and short selling possible. For banks, prime brokerage is a significant and profitable business, though one with real risks, as the Archegos collapse in 2021 showed.

Core prime brokerage services#

How prime brokers earn money#

The largest prime brokers have historically included Goldman Sachs, Morgan Stanley and JPMorgan, alongside other global banks.

Synthetic prime brokerage#

Instead of lending money to buy shares, a prime broker can give a fund the same exposure through a total return swap: the bank holds the shares and pays the fund the returns, while the fund pays financing costs. This can offer higher leverage and keeps the fund off public ownership registers, since the bank legally owns the shares. That opacity played a central role in the Archegos case. See Swaps Explained.

Risks in prime brokerage#

After Lehman, many hedge funds spread their business across several prime brokers to reduce dependence on one.

Multi prime arrangements#

Larger funds commonly use two or more prime brokers, which reduces counterparty risk and improves financing terms, but adds operational complexity. Reconciling positions across primes becomes a key operational task. See Trade Accounting and Reconciliation.

For a closer look at the firms that provide these services and how funds choose them, see Prime Brokers.

Frequently asked questions#

What is a prime broker?#

A bank or broker that provides hedge funds with financing, securities lending, clearing, custody and consolidated reporting.

How do prime brokers make money?#

Mainly from interest on margin loans, fees for lending securities, financing spreads on swaps and related trading services.

Why did Archegos cause such large losses?#

It built huge, concentrated, leveraged positions through swaps with several banks that could not see its total exposure, and when prices fell it could not meet margin calls.

Next, learn how to pick a broker for your own trading in How to Choose a Broker.