Prime Brokerage Services, Example, Requirements for an Account

A custodian financial institution keeps hedge fund custodian the securities owned by individuals and organizations safe. This serves an important purpose since financial securities must be cleared and settled properly, with various regulatory and accounting procedures met. A custodian bank may have the right to take possession of assets if required, often in conjunction with a power of attorney.

How Hedge Funds Select a Prime Broker

They serve as an additional layer of security, safely holding a mutual fund’s portfolio, managing record-keeping, and helping reduce the possibility of fraud. A custodian is a specialized financial institution (typically, a regulated entity with granted authority like a bank) that holds customers’ securities for safekeeping in order to minimize the risk of their misappropriation, misuse, theft, and/or loss. A prime brokerage generates revenue in a few different ways, including overall fees, commissions on transactions, and lending charges. They also charge different rates depending on the volume of transactions a client does, the number of services a client uses, and so on. Another https://www.xcritical.com/ investor-related area—one which we’ve seen significant interest—is help completing alternative investment subscription documents on a manager’s behalf. This can include completing the core offering documents as well as AML and KYC requirements for each investor.

Requirements for Prime Brokerage Accounts

Since a mutual fund is essentially a large pool of funds from many different investors, it requires another entity to hold and safeguard the securities the investors mutually own. The custodian is often referred to as the gatekeeper of assets whose function is to track monies and assets moving into and out of the account; and they are entrusted to render regular financial valuation of such assets held in custody. Margin is when a prime broker lends money to a client so that they can purchase securities.

Are Prime Brokers Just for Hedge Funds?

Against a backdrop of shifting regulation, rising allocation, and convergence across strategies, the strategic value that custodians can add is increasingly coming into focus. For hedge fund and liquid alternative managers, the right custodian can enable growth strategies via additional yield generation, cash optimisation, hedging, financing, and distribution benefits. Beyond the pivot towards illiquids, client demand and regulatory pressure is resulting in more hedge funds embracing ESG (Environmental, Social, Governance) – and this is something service providers need to accommodate for.

Are There Custodians Other Than Banks?

In essence, a prime brokerage service gives large institutions a mechanism allowing them to outsource many of their investment activities and shift focus onto investment goals and strategy. Bank custodians like UMB may also be able to support alternative managers even further throughout the investment lifecycle with traditional banking and escrow services, investor servicing and fund administration. Clients are also privy to the prime broker’s private research services, thus enhancing and reducing the fund’s research costs. Outsourced administration and trustee services, along with enhanced leverage enabled by offering lines of credit, are additional features offered by many prime brokerage firms. This exemption may cease to be available however if the private placement regimes are phased out from 2018.

In this article, we focus on the role of prime brokers and how large investment clients choose the right one. A true custodian bank would have assets under custody separate from the bank’s balance sheet and maintained as distinct from bank assets not subject to bank creditors. Assets under custody by a qualified custodian are different and should not be construed as a bank deposit and/or brokerage account. Protection against bankruptcy or insolvency of the adviser or custodian is established by segregating the assets and identifying them as being held on the client’s behalf. A prime brokerage is a bundled group of services that investment banks and other financial institutions offer to hedge funds and other large investment clients. They often need to be able to borrow securities or cash to engage in netting, which offsets the value of multiple positions or payments exchanged between two or more parties.

While lending cash is a commodity service with a transparent cost structure, lending securities is not. Capital Fund Law Group has authored numerous investment fund publications, including instructive eBooks, white papers, blog posts, and sample offering document excerpts with illustrative footnotes. These complimentary downloads are dedicated to helping fund managers understand the legal fundamentals of launching and operating an investment fund. Potential investors in a hedge fund may also be influenced by the selection of a particular prime broker—either positively or negatively.

Prime brokers will also be required, from 1st March 2011, to provide detailed daily reports to their clients which are to include comprehensive details of the client’s assets and financing obligations in relation to the prime broker. Many global financial firms offer custody services for all types of investments, including stocks, bonds, mutual funds, and exchange-traded funds. Fidelity, a federally regulated bank holding company, often acts as its own custodian. Selecting the right prime broker is always a very important decision for a hedge fund manager, regardless of whether they are a new start-up or a multi-billion dollar fund closed to further investments.

• As the funds landscape continues to evolve, custody is increasingly becoming a value-adding function for hedge fund and liquid alternative managers’ distribution and investment growth strategies.
• It became evident to many managers in the aftermath of the financial crisis that there was a lack of detailed collateral reporting to support risk and compliance monitoring.
• There is a limited exception where the law of a third country requires financial instruments to be held in custody by a local entity.
• The services provided under prime brokering include securities lending, leveraged trade execution, and cash management.
• This exemption may cease to be available however if the private placement regimes are phased out from 2018.
• Each Advisor, Proprietary Trading Group STL and Multiple Hedge Fund master account holder can add client, sub and hedge fund accounts as required.

Bank customers should be familiar with such activities and the products that represent them. The difference between custodian banks and traditional banks is their primary roles. Item 15 of Form ADV Part 2 (the Brochure) requires additional disclosures for those managers who have instructed qualified custodians to send account statements directly to the investors. For more information read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD). Alternatively, please contact IB Customer Service to receive a copy of the ODD.

These important developments have contributed to increasing high net worth investors’ comfort with Liquid Alternatives and the growth of custodian services for long/short funds in general. With foundational changes instituted since 2008, the imperative that drove investors to demand greater transparency from their fund managers also prompted custodians and prime brokers to alter their service offerings for long/short funds. Long/short funds now have a variety of custody and leverage service models to choose from including Prime Custody, Enhanced Custody and other prime brokerage/custody hybrids. Most prime brokers are large Wall-Street institutions that are generally not able to service a hedge fund until it reaches a substantial threshold of assets under management. However, mini-prime brokers or “introducing brokers” act as a liaison between a hedge fund and the large prime broker. Introducing brokers provides startup fund managers access to the full range of services provided by prime brokers.

As with more traditional offerings, participation in any of the concierge services is optional. The Securities and Exchange Commission (SEC) has specific rules and requirements governing the custody of mutual funds, outlined primarily in Rule 206(4)-2 of the Investment Advisers Act of 1940. These regulations, revised in 2009 to improve transparency and investment safety, aim to mitigate the risks of fraud by investment companies and fund managers.

Identity of the depositaryThe depository should be an EU credit institution or investment firm or a third country equivalent that is subject to the same standard of prudential regulation and is effectively supervised. A prime broker acting as counterparty to a fund can act as a depositary for that fund provided that the depository function is “functionally and hierarchically separate” from the rest of the prime broker’s business and conflicts of interest are appropriately managed. A depositary may delegate the custody functions to a prime broker provided that the relevant conditions are met, as set out below. Even where the prime broker is only acting as custodian and not as depositary, the wording of the text of the AIFMD suggests that the prime broker would be required to comply with the “functionally and hierarchically separate” requirement. This program is provided free of charge to all hedge funds who use IBKR as their principal prime broker, have at least $3 million in assets under management and an audited track record of at least one year or have done its trading at IBKR for the last year. This one-stop solution is perfect for institutions looking to reduce costs and improve productivity with a fully integrated OMS/EMS setup.

The Investment Company Act of 1940 regulates the custody of mutual fund assets. Under the Act, mutual funds and custodians both need to register with the Securities and Exchange Commission. The fund’s assets, its underlying securities, are kept with the third party to reduce the risk of unscrupulous brokers taking advantage of the fund. The custodian may also keep records for the fund or track other information as needed. A custodian bank takes on the responsibility of safeguarding the financial assets of individuals and institutions.

Custodian banks are depository institutions, meaning they have to comply with Federal Reserve standards and possess the proven infrastructure for all non-negotiable requirements based on federally mandated wiring protocols. As the funds landscape continues to evolve, custody is increasingly becoming a value-adding function for hedge fund and liquid alternative managers’ distribution and investment growth strategies. BNP Paribas Securities Services looks at the drivers behind this – together with some of the criteria which hedge funds should consider when selecting their custodians. For hedge funds or other institutional clients to get the kind of services that make having a prime brokerage account worthwhile (most notably discounted fees for trading), an account size of $50 million in equity is a likely starting point. Where assets held in custody are lost, the depository is obliged to return identical financial instruments or the corresponding amount to the fund or the manager acting on behalf of the fund without undue delay.

Private fund custody services can extend even further to areas relating closely to the investor base of an alternative fund. These investor-related services can end up making a huge difference in managers’ operational efficiency. One such area is online reporting, via an investor portal that allows investors self-service access to account information. The primary duty of a third-party custodian is loss prevention by safeguarding assets. All registered funds, even those with alternative strategies, are required by law to use a custodian, who ‘sit between’ the investment manager and the assets themselves, for everyone’s protection. ConclusionIn the wake of the Lehman insolvency, the protection of client money and assets is coming under increased regulatory scrutiny.

In practice, however, the results of these matchmaking services can be highly varied. At the very least, these services can expedite the fundraising process for strategies and individual principals currently favoured by the market. Although in recent years prime brokers have expanded their services to include risk management and capital introduction, securities and cash financing remains their core (and most profitable) services. In addition to execution and custody services, a prime broker provides hedge funds with the ability to borrow stocks and bonds (known as “securities lending”) and to borrow money to buy stocks and bonds (known as “margin financing capabilities”). Nonetheless, hedge funds are turning to custodians to supplement – rather than replace – the services already provided to them by their existing prime brokers. While hedge funds are important to prime brokers’ business, other large investment clients that need clearing services, or to be able to borrow securities or cash in order to engage in trading would also need a prime broker.

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The Federal Reserve is monitoring the processing of OTC derivatives closely, and are working with the financial services industry to ensure that infrastructure is not only scalable and efficient, but that it also manages operational risk effectively. The need to reduce confirmation backlogs puts the responsibility back on fund managers and their designated custodians to work together. The custodian community and fund managers continue to work toward operating in a Straight-through Processing (STP) environment in order to mitigate risks. Regulators have rightfully highlighted the importance of utilization of electronic trade confirmation platforms as being fundamental to risk management.