What Is Prime Brokerage?

I’ve noticed that there is a dearth of information and answers about this area of Wall Street here on WSO, so I’ve decided to give a basic overview of prime brokerage—what it is, how it fits in the overall picture, and what its responsibilities are. To really drive home the explanations, over the next few weeks I’ll be featuring some real-life stories from the prime brokerage arena, told from the perspective of a close family member who spent about 30 years in the business.
You’ll hear about the frauds he uncovered, the laughs he enjoyed, and of course, the characters he encountered.

But these stories aren’t going to make a whole lot of sense unless we have a primer on Prime Brokerage.

There are many, many ways to make a buck in this industry; for those who don’t mind tearing their eyes away from banking, trading, or consulting, read on for one of them…

So what is prime brokerage?

Prime brokerage (PB for short) is a service provided by a registered broker-dealer that handles centralized custody, securities lending, financing, and margining, and regulatory reporting for both individual and institutional clients.

Put another way, in the client service functions of a broker-dealer, someone has to issue the margin calls, establish the clients’ reporting and netting structure, resolve disputes, and keep their eyes open for regulatory issues (which include Reg T at the Federal Reserve Board level, Rule 4210 at the FINRA level, and whatever in-house custom requirements are set by your bank). That someone is your PB unit.

Why would a client want to use a prime broker?

The most important reason for a client to use a prime broker is for netting.

Think about it: from a client’s perspective, would you rather maintain accounts at a dozen different brokers (and by extension, have to keep tabs on a dozen different places for risk, fees and exposure), or maintain a presence at a single entity that consolidates all of that centrally?

With a prime broker, clients can essentially net their risk exposure by taking advantage of all the deals and special relationships the prime broker has.

How does a Prime Brokerage Unit make money?

One of the ways a PB unit makes money is through “rehypothecation,” a process that is done by your stock loan desk. Rehypothecation essentially lets the firm re-use client collateral for its own trading and borrowing purposes—allowing for more flexibility, and potential profit, for the firm. This can be a MAJOR source of income.

There are also fees based on how much margin is extended to a client, as well as custody and clearing fees.

Now that we have a basic, high-level overview of what prime brokerage is, beginning next week I’ll start in on its importance to the Street in the prime brokerage stories...

 
Bobb:

knew a guy in a capital introduction role at a BB in their prime brokerage division. Seemed like a pretty good job

Funnily enough, I knew a guy in prime brokerage at a BB as well and I thought his job sounded miserable. Other than a high profile name on his resume, he basically just cleared trades for HFs all day from a remote location. However, I'm sure there are many facets to PB, looking forward to learning more about them.

 
milehigh:
Bobb:

knew a guy in a capital introduction role at a BB in their prime brokerage division. Seemed like a pretty good job

Funnily enough, I knew a guy in prime brokerage at a BB as well and I thought his job sounded miserable. Other than a high profile name on his resume, he basically just cleared trades for HFs all day from a remote location. However, I'm sure there are many facets to PB, looking forward to learning more about them.

Clearing trades is boring. Capital intro can be fun thou. It is essentially a fundraising/placement role where you connect managers (especially emerging managers) with potential investors. Capital intro is usually considered a loss leader within prime brokerage as they don't charge manager money for doing this. Instead they seek to help their client managers grow and then make money off them through other means, like ITF described. Also women in capital intro are pretty (compared to finance as a whole).

Too late for second-guessing Too late to go back to sleep.
 
my man:

So is Cap Intro a female-dominated part of Prime Brokerage?

Not really. Most of the people in Capital Intro I know are still men. But then I am not too familiar with that field as I am not in the hedge fund business and don't use prime brokers. Someone from the HF space can provide more comprehensive information on this than I do.

Too late for second-guessing Too late to go back to sleep.
 
huanleshalemei:

Great introduction of pb, thank you! Just realized how ignorant I am. Look forward to you next post :)

Yup, looking forward to "shining a little light" on this area.

Metal. Music. Life. www.headofmetal.com
 
moneyneversleeps88:

Is your team different from the pricing team? Or are you guys one team?

The pricing team is separate from mine, while I do work with them on a regular basis. I'll usually hit them up to see if if we can get a bond quoted on a regular basis. There's another team that works on the pricing of more complicated derivatives.

 

MS is clearly the best prime broker on the street. Globally they hold about 1/3 of all hedge fund assets. MS invented this business and is a pb for over 90% of the alpha 100. They usually garner the most awards of any primebroker because of their dominant position. GS is a close number 2. 3rd place and below is distant to these two leaders. Below the top two spots it is a tossup between UBS, Merrill, and BS.

I will post some introductory stuff later.

The Prince of Wall Street

http://www.princeofwallstreet.com

 

That would be great to read. I have a PB super day coming up with MS, and it's not the easiest division to gain info about.

From what I can tell, you can really get stuck in back office work, or you can be a salesman, either selling the firm or being a liason between HF and investors.

How easy is it to move from front office PB to something else?

Any and all elaborations would be great. Thanks.

 

I PMed this message to a few people who asked but here it is for everyone.

I mainly know MS PB so I will answer your questions for that. PB makes money lending money for leverage and stock for short sales to HFs. On the money lending it is a spread financing business. Borrow at a rate lower than you quote the client. On the short sale side you borrow stock from clients for a fee or for free then charge a fee to HFs to borrow the stock.

The best action in PB is on the sales team and in securities lending. The people who run PB work in these groups. Cap Intro and then the Consulting Group are 3 and 4. As a sales person you will not be selling securites like in S&T to hedge funds. You will basically be in a "banker" like role for hedge funds. You will figure out how to finance HFs and how to price them. You will basically be their conduit into the firm. You will work with the top guys at the HF (i.e. PM, CFO, COO, etc.). In sales you will own the relationship with that firm. You will also determine how to price them for stock loan. Sales people get paid the best of anyone in PB.

Sec Lending is more like an S&T job since you are trying to source supply and give the best rates for stock to borrow to HF clients. Tend to be very math competent people in this job. They really like finance majors, quant. finance, and finance engineering people.

CapIntro will give you a very good intro into the business landscape. If you work at MS you will get to see the offering docs for all the largest HFs. You will spend lots of time seeing how to launch a fund and participating in some launches. You will also learn a lot about industry dynamics.

When you say back office you are probably talking about Client Relationship Managers. These people are basically the first call for traders, PMs, and ops people at the HFs. They cover maybe 3-5 hedge funds. If someone gets a messed up trade or a messed up report, they call this person. This job is not really front office but it isn't back office.

PB is a great place to be and it is a great stepping stone to other parts of the firm. It is very profitable, probably the most profitable business on wall street, with very strong growth. GS and MS book over $2bn of revenue each year from these ops and PB is essential to the success of your S&T business since the PB relationship is sticky.

The Prince of Wall Street

http://www.princeofwallstreet.com

 

Couldn't find any readily available comprehensive primers. Here's some stuff to get you started though.

http://en.wikipedia.org/wiki/Prime_brokerage http://www.wallstreetoasis.com/forums/ask-me-any-question-you-have-abou…

Wiki article is pretty well-written and DrNo's posts give further color. Usual caveat some of this info is dated and the forum entry is specific to one dude. For example, DrNo's posts suggest trading groups fall under purview of PB. In many cases, PB is probably an internal counterparty to sec lending / repo desk. Thus for anyone looking to trade the short-term funding markets, PB may not be the right area.

Similarly, with regulatory pressures mounting, PB may no longer be as rosy as DrNo's entries suggest. This JPM article discusses some implications of capital rules on PB:

https://www.jpmorgan.com/cm/BlobServer/is_leveragingtheleverage.pdf?blo…

 
blankplank:
Hello, does anyone know how does the quant prime brokering work? How does it differ from the traditional brokerage role?

Do you mean something like the quants working at JP's Equity Finance quant team? Would like to learn more about that as well.

 

Hi thanks for posting this topic! I have a question about prime brokerage funding, how do they fund their assets? For example if they use repos or securities loaned to fund their assets, how do they get funding to repos at the first place? It seems very circular or I think I'm just not understanding it at all.  Also could you please talk about internalisation within this business as well? Thanks very much!

 

Internalization is just netting of longs and shorts. In the ideal case you have clients going both long and short and you make a financing spread on both. Banks will use what's called axes to find the perfect netting (encourage a client to go short via cheaper financing if overall book is net long etc, usually done by a distribution desk within prime). If you are not perfectly netted you borrow securities from lenders (short financing) or repo (long financing). What you cannot fund out you borrow from the firm's treasury. This is cash prime. There is also synthetic prime where you can fund synthetically by putting together a funding basket with a counterparty to improve your netting.

 

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