What is a Prime Broker?

A prime broker is usually a large bank or an investment company providing a wide range of services to hedge funds related to clearing, operational support, settlement of transactions and risk management. A brokerage company, a trading office, an operational office and a managing company, which help hedge funds to solve various tasks, are included in the structure of a prime broker.

Development of a prime-brokerage

The prime brokerage service originated in the 1970s due to the rapid development of hedge funds. Large investment banks started to offer their services to hedge funds for a certain fee: credits on favorable terms, technical support, accounting services and research, and they also found major investors. Since the middle of the 2000s, the popularity of prime-brokerage services began to decline, and during the global financial crisis of 2008, their number sharply decreased following the decline in the number of hedge funds and assets under their control.

After the bankruptcy of the largest US investment bank Lehman Brothers, hedge funds, which received margin financing from the bank, could not retrieve their assets transferred to the bank as collateral. Credit ratings of many prime brokers were also reduced during the crisis, and hedge funds began to move to banks with the best credit rating, because when making transactions on behalf of the prime broker, the high rating of the company was of a great importance. After the crisis, hedge funds, which were using the services of one prime broker, started to use services of several companies for risk diversification.

In addition, prime brokers’ requirements for the provision of loans received by hedge funds increased: 30-40% of the capital in case of trading high-yield bonds instead of 10-15%.

Forex prime brokers

Forex prime brokers are high liquidity providers - the largest banks known across the world: Bank of America, Barclays Capital, Morgan Stanley, Deutsche Bank and others.

Forex prime brokers make transactions on behalf of and at the expense of smaller banks and brokers and act as their guarantor in the interbank market, because a brokerage company and particularly a private investor cannot make large transactions independently. After making a deal with a client, the prime broker automatically makes the opposite transaction in the interbank market to prevent risks of the parties.

Only those Forex brokerage companies that work maximally transparent and have a license from reputable regulators, may enter into an agreement with a prime broker and take clients’ deals to the interbank market.

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