What are prime brokers? Investing Explained

In this series, we bust the jargon and explain a popular investing term or theme. Here it’s prime brokers. 

What sort of brokers are these?

A prime broker provides a range of services to a hedge fund or a family office – a business that manages the millions or billions of a wealthy dynasty.

These services, which aim to help them execute their trading strategies, include the provision of finance, research and administrative back-office support.

Global banks control the prime brokerage sector, which they regard as a route to selling other services, such as wealth management, to clients.

Until lately, prime brokerage rarely made the headlines. But that changed this summer as the spotlight has turned to the crucial role of ‘primes’ in the existence of hedge funds which manage assets of about $4.5 trillion worldwide.

Prime brokerages are hedge funds’ main source of funding – ‘their lifeblood’, according to George Evans of Convergence, a specialist analytics group.

Why are they in the news?

After scandal engulfed the Odey Asset Management hedge fund this week, Goldman Sachs and other prime brokerages – including Morgan Stanley and Exane – severed links with the fund over the tide of allegations of sexual misconduct by its founder and former boss Crispin Odey.

Without prime brokerage support, the fund would be unable to continue to trade. Odey no longer has any ‘economic or personal involvement’ in the partnership.

Any other reasons?

Yes. There is a heightened focus in the stocks in which prime brokers are dealing on behalf of clients – as this provides a guide to the direction of stock markets.

For example, it became evident this month that some funds had failed to spot the rally in shares in the technology companies that stand to benefit from the growth of ‘generative’ AI (artificial intelligence).

Prime brokers were scurrying, in particular, to obtain exposure to the mega-tech semiconductor group Nvidia. Its shares have leapt by around 200pc this year.

Is prime brokerage lucrative?

Yes, which is why there is such a fight to seize a bigger slice of the action. The three biggest names worldwide are Goldman Sachs, JP Morgan Chase and Morgan Stanley. But Barclays and Exane are jostling for position.

The fees received by all the players in the sector total about $15billion a year. But although prime brokerage is profitable, it is also labour-intensive. The competition has become cut-throat because the number of hedge funds is reducing.

Also it is a high-risk business. The failure of US hedge fund Archegos Capital was a factor in the downfall of its prime broker Credit Suisse. The bank suffered heavy losses as a result of the relationship.

What else do prime brokers do?

If the client wants to short a stock, believing its value will fall, the prime broker will borrow the shares to carry out this transaction from a pension fund or other holder.

The shares are sold in the hope that they can be bought back at a lower price, with all parties, including the shares’ owner, making some money.