Prime brokers will have dedicated client services departments to provide back-office support for their clients to handle complex corporate actions, clearing issues, and general account management.
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What are risk management and financing in prime brokerage?
Risk management and financing are closely linked prime brokerage services that help hedge funds control their market exposures while accessing the capital and liquidity required to run their investment strategies.
Financing is particularly important for hedge funds using leverage. A prime broker can provide funding against a fund’s assets, allowing the manager to increase market exposure without providing the entire value of a position in cash. Financing can also support short selling, derivatives trading and other strategies where capital and collateral need to be managed efficiently. The cost and availability of this financing can have a significant impact on a hedge fund’s overall returns.
Risk management focuses on identifying and controlling the financial risks created by these positions. Depending on the strategy, this could include equity, interest-rate, currency, commodity, liquidity and counterparty risk. Prime services providers can give managers access to derivatives and hedging instruments including futures, options, forwards, swaps and other OTC products.
StoneX, for example, provides access to interest-rate swaps as well as FX spot, forwards, swaps, NDFs and options. Its FX services can be used by hedge funds and asset managers to hedge currency exposure arising from investments in international markets.
Prime brokers also manage their own exposure to hedge fund clients. They monitor positions, collateral, leverage and margin requirements and may require funds to provide additional collateral when markets move against them. This makes the financial strength and risk controls of the prime broker itself an important consideration.
For hedge funds comparing prime brokers, financing should therefore be assessed on more than simply the headline interest rate. Managers should consider financing spreads, margin requirements, availability of leverage, collateral treatment, liquidity, FX financing and how quickly terms could change during volatile markets.
For highly leveraged strategies in particular, the quality and stability of a prime broker’s financing relationship can be just as important as its trading execution.