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Prime brokerage is a business. A financing business, to be exact. In other words, it’s a bundle of services offered to large investment clients and hedge funds.
A prime brokerage account can be used by clients in different ways, from finding new investors to accessing research or borrowing money.
The prime broker is always going to be a financial firm. It will be an important point of contact for the client. It manages the relationship with the client and maintains custody of the client’s assets.
So, whenever the client aims to perform a transaction, they will go through brokers. But what are the requirements to open a prime brokerage account? We’ll tell you all you need to know on the subject in this article.
What is a prime brokerage?
Prime brokerage consists of a group of services that financial institutions offer to large investment clients. That includes hedge funds.
The prime brokerage agreement is the agreement that stipulates the services that a prime broker is contracted for by the client. It includes all the details of the contract, from fees to terms, requirements and transaction levels.
The prime brokerage agreement is basically a contract signed between a client and an investment bank. The bank engages in offering certain special services to the client. In turn, the client must pay prime brokerage fees.
You must know that this type of service isn’t available to everyone. Most clients won’t need it either. It’s niched to hedge funds and other large financial institutions.
Clients usually look for a prime brokerage account when they need the option to borrow cash or securities. They can use those funds to access costly research or to find investors, for example.
Prime brokers allow clients to borrow securities. This way, they can increase their leverage. Prime brokers can be a buffer between hedge funds and commercial banks or pension funds.
So, a prime broker is basically a large financial institution that deals with other high-caliber financial institutions. Most large banks have a prime brokerage unit with many clients.
Prime brokerage services include:
· Financial reporting
· Cash and security lending
· Custody of assets (safekeeping a client’s securities)
· Financial consulting (risk management)
· Introductions to new possible investors.
These services are supposed to support a client’s financial activity. In some cases, an agreement can include operational support (office space, parking, etc.), especially when a hedge fund has small teams.
The client is assigned a broker or more brokers who provide the services agreed upon.
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How does a prime brokerage agreement work?
A prime brokerage agreement can happen between two parties. One is the investment client and the other is the financial institution that offers the services.
Any prime brokerage agreement means that the client pays some fees. The amount of those fees depends on certain factors, such as:
· The number of requested services
· The amount of money the client borrows
· Transaction volume
· Securities borrowed for short trades.
When talking about securities lending, the prime broker usually asks for collateral. Collateral can minimize risks and gives faster access to funds.
Not all financial companies can provide prime brokerage services. It’s mostly big investment banks who reign this segment. The biggest names on the market are:
· J.P. Morgan
· Goldman Sachs
· Bank of America
· Morgan Stanley
· Charles Schwab
What is the minimum financial requirement to get prime brokerage services?
We’ll keep this short and simple. Prime brokerage clients are legally obliged to own a certain amount in order to benefit from brokerage services.
In order to get prime brokerage services, a hedge fund or any other type of professional investor needs $500,000 in equity. That’s the minimum amount required to be able to access the services.
So, you can apply for a prime brokerage account with $500,000 in equity. But most existing clients are much, much larger than that. Some clients have over $50 million in equity.
Take into account that minimum equity accounts are less likely to get benefits over what a discount broker would offer, anyway.
Yearly revenue can be important, too. To open an institutional prime brokerage account, you need to have at least $50 million in equity. And your yearly revenue should be over $200,000. According to most financial advisors, this is more of a starting point when you’re looking for great benefits and services.
It’s possible to get these services with a fraction of these numbers, too. But only if you are a prestige client. Meaning you are a reputable money manager, or you have a very promising hedge fund that a broker wants to grow.
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Do you need a prime brokerage account?
Not everyone needs a prime brokerage account. In fact, if you don’t have a hedge fund or another type of high-volume trading operation, chances are you won’t require one.
Most day traders don’t need this service. And those who are beginners in the world of investing are better off considering stock-brokering services, anyway. That option has everything they need to get started.
After some good trades, maybe the client will set up a hedge fund or build a large-scale trading operation. That’s the moment when a prime brokerage agreement can come into place. Until then, most people shouldn’t have to worry about such facts.
Who can ask for a prime brokerage account?
As previously mentioned, not all finance enthusiasts need or require prime brokerage accounts. You’ll often see clients like pension funds, hedge funds or commercial banks. Some money managers or large-scale investors will also make the cut.
Pension funds are an institutional investor that usually deals with large sums of money. Although it’s for investments, they lack in internal resources needed to manage the investments. This is where a prime brokerage account comes in.
Why choose a brokerage instead of a prime broker account?
The difference is in the scope of business. A broker is simply one person or entity that has the role of facilitating the purchase or sale of equities—for example, selling or buying stocks and bonds.
The prime broker is represented by a larger institution that can and will provide a larger array of services. That includes cash management, risk management, securities lending and capital introduction.
What are the charges?
Of course, we can’t talk about a prime brokerage account without taking into consideration the charges. Each client gets a personalized rate. It depends on the number of services required and the volume of transactions.
And every prime broker can choose its fees. There can be monthly fees and transaction fees. Or both! Sometimes, a broker will charge a percentage of the borrowed amount, for example. It all depends on the agreement between parties.
The bottom line
Prime brokerage agreements are an essential service aimed at large institutions and clients. Of course, they are meant to help clients outsource activities and streamline their business in order to allow them to focus more on their main tasks.
But not everyone needs such services, as mentioned above. Certain requirements apply, of course. Prime broker accounts can be just what some large institutions need to reach the next step in making their business moves and decisions easier.