Prime brokerage is the generic name for a bundled package of services offered by investment banks and securities firms to hedge funds and other professional investors needing the ability to borrow securities and cash to be able to invest on a netted basis and achieve an absolute return. The prime broker provides a centralized securities clearing facility for the hedge fund so the hedge fund’s collateral requirements are netted across all deals handled by the prime broker. These two features are advantageous to their clients.

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Services [ edit ]

Each client in the market of a prime broker will have certain technological needs related to the management of its portfolio. These can be as simple as daily statements or as complicated as real-time portfolio reporting, and the client must work closely with the prime broker to ensure that its needs are met. Certain prime brokers offer more specialized services to certain clients.

For example, a prime broker may also be in the business of leasing office space to hedge funds, as well as including on-site services as part of the arrangement. Risk management and consulting services may be among these, especially if the hedge fund has just started operations.

The following services are typically bundled into the Prime Brokerage package:

• Global custody (including clearing, custody, and asset servicing)
• Securities lending
• Financing (to facilitate leverage of client assets)

• Customized technology (provide hedge fund managers with portfolio reporting needed to effectively manage money)
• Operational support (prime brokers act as a hedge fund’s primary operations contact with all other broker dealers)

In addition, certain prime brokers provide additional value-added services, which may include some or all of the following:

• Capital Introduction — A process whereby the prime broker attempts to introduce its hedge fund clients to qualified hedge fund investors who have an interest in exploring new opportunities to make hedge fund investments.
• Office Space Leasing and Servicing — Certain prime brokers lease commercial real estate. and then sublease blocks of space to hedge fund tenants. These prime brokers typically provide a suite of on-site services for clients who utilize their space. This is typically called a hedge fund hotel.
• Risk Management Advisory Services — The provision of risk analytic technology, sometimes supplemented by consulting by senior risk professionals.
• Consulting Services — A range of consulting / advisory services, typically provided to start-up hedge funds, and focused on issues associated with regulatory establishment requirements in the jurisdiction where the hedge fund manager will be resident, as well as in the jurisdiction(s) where the fund itself will be domiciled.

History [ edit ]

The basic services offered by a prime broker give a money manager the ability to trade with multiple brokerage houses while maintaining, in a centralized master account at their prime broker, all of the hedge fund’s cash and securities. Additionally, the prime broker offers stock loan services, portfolio reporting, consolidated cash management and other services. Fundamentally, the advent of the prime broker freed the money manager from the more time consuming and expensive aspects of running a fund. These services worked because they also allowed the money manager to maintain relationships with multiple brokerage houses for IPO allocations, research, best execution, conference access and other products.

The concept and term prime brokerage is generally attributed to the U.S. broker-dealer Furman Selz in the late 1970s. However, the first hedge fund operation is attributed to Alfred Winslow Jones in 1949. In the pre-prime brokerage marketplace, portfolio management was a significant challenge; money managers had to keep track of all of their own trades, consolidate their positions and calculate their performance regardless of which brokerage firms executed those trades or maintained those positions. The concept was immediately seen to be successful, and was quickly copied by the dominant bulge bracket brokerage firms such as Morgan Stanley. Bear Stearns. Merrill Lynch. Credit Suisse. Citigroup. and Goldman Sachs. At this nascent stage, hedge funds were much smaller than they are today and were mostly U.S. domestic long-short equities funds. The first non-U.S. prime brokerage business was created by Merrill Lynch’s London office in the late 1980s. Post the 2007 — 09 financial crisis new entrants came to the market, such as State Street [ 1 ] with a custody-based prime brokerage offering.

1980s to 2000s [ edit ]

Through the 1980s and 1990s, prime brokerage was largely an equities -based product, although various prime brokers did supplement their core equities capabilities with basic bond clearing and custody. In addition, prime brokers supplemented their operational function by providing portfolio reporting; initially by messenger, then by fax and today over the web. Over the years, prime brokers have expanded their product and service offerings to include some or all of the full range of fixed income and derivative products, as well as foreign exchange and futures products.

As hedge funds proliferated globally through the 1990s and the 2000s, prime brokerage became an increasingly competitive field and an important contributor to the overall profitability of the investment banking business. As of 2006, the most successful investment banks each report over two billion dollars in annual revenue directly attributed to their prime brokerage operations (source: 2006 annual reports of Morgan Stanley and Goldman Sachs).