What Is a Prime Brokerage Agreement?

Some traders need a high level of support -- enter the prime brokerage.

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Large institutions don’t invest in the capital markets like you or I. While we use a brokerage to snap up or sell the occasional stock or mutual fund, they’re trading on a regular and often heavy basis. They also do more than just buy long and sell; frequently they also short-sell stocks, use options, or avail themselves of a number of different securities trading instruments.

Because of this intensity and scope, the standard online brokerage account that’s sufficient for we the investing public won’t cut it for an institution. Instead, such clients require a prime brokerage agreement to secure the wide spectrum of financial services they’ll need.

But what exactly is a prime brokerage? I hear you say. I’m glad you asked; here’s the answer.

What a prime brokerage offers

Institutional investors that actively trade on the capital markets tend to do so in a variety of ways. Besides the aforementioned long, short, and options trading, they might also engage in activities like margin trading (i.e. purchasing securities with borrowed money).

On top of that, they also need more basic services to support their operations. A good example is custody, in which a third party holds a client’s securities for safekeeping.

So at the end of the day, a prime brokerage provides a package of services that support their client’s activities in the financial market.

Some of the busiest buyers and sellers of securities and related instruments are hedge funds. Perhaps surprisingly, despite having large piles of money under management these are typically small operations in terms of personnel. They don’t have enough bodies to do the often great amount of direct work required to trade securities, hence the need to outsource it.

Who offers prime brokerage services?

With the amount and depth of prime brokerage services, there aren’t a lot of companies that can provide them. For the most part, they’re the domain of the big investment banks.

As they’re investment banks and like to get paid for everything they do, these companies charge clients at pricey rates for this. The amount invoiced depends on a number of factors, which can include but is not limited to:

  • Total number of services
  • Transaction volume
  • Amount of money borrowed for margin finance
  • Number of securities borrowed for short trading

The most high-profile players in the prime brokerage game are familiar names in the world of finance. Here are six big financiers actively offering prime brokerage services; note that these companies also provide traditional brokerage services for individuals:

  • Goldman Sachs
  • Bank of America Merrill Lynch
  • J.P. Morgan (part of JPMorgan Chase)
  • Morgan Stanley
  • Citigroup (owner of Citibank)

Do you need a prime brokerage agreement?

Unless you run a hedge fund or some other type of high-volume securities trading operation, it’s extremely unlikely that you require a prime brokerage’s services. Even day traders who transact several times daily don’t really have this need, since their buying and selling tends to be fairly straightforward without involving many derivatives or gobs of margin finance.

This, naturally, begs the question -- if I’m just an individual who likes to buy and sell stocks, what type of services should I use?

In nearly every instance you’ll want a traditional securities broker, most likely one known as a discounter (the definition of discount brokerage is a bit loose; basically it means a broker that charges modest fees for trading, and offers a limited number of auxiliary services). If you’re new to securities trading, consider a brokerage more suited to beginners.

Perhaps your transacting with such a broker will go so well that you’ll be able to set up your own hedge fund or large-scale trading operation. In that case, you might very well need a prime brokerage agreement… but until then, your needs are modest and you shouldn’t worry about it.