In the financial sector, prime brokers offer a package of services to hedge funds and other large investors to enable them to engage in the financial market more effectively. A fundamental part of this package is that the prime broker helps ensure the matching of sellers of securities to buyers. This is much more efficient than if parties would have to seek out buyers or sellers individually. Securities lending, leveraging and operational support are also almost always part of the package.
To get access to a prime brokerage, a fund needs a minimum of $500,000 in equity in the US. However, minimum collateral requirements are often in the tens of millions of dollars, and larger clients tend to get access to more benefits. Therefore a market has opened up for smaller, more boutique prime brokerage. This allows funds, particularly start-ups, smaller funds and mid market players to cater to investor expectations as they grow.
Additionally, smaller prime brokerages can offer a more closely tailored and personalised service. In our contemporary climate of extremely volatile markets, where funds are confronted with opportunity for significant loss or gain, funds can benefit from, for example, bespoke technology solutions for managing a portfolio.
Larger banks continue to pivot away from prime brokerage. For instance, in the wake of the Archegos Capital Management scandal, where the fund defaulted on margin calls to several prime brokers, Credit Suisse terminated its prime brokerage business entirely. Increased market volatility will therefore further increase risk and likely deter larger prime brokers or force them to increase collateral requirements further to offset the risk. Smaller prime brokers are gaining market share: flexibility, a nimbler approach and the ability to support clients on an account by account basis has meant better solutions are being leveraged continuously by the boutique primes, meaning small to medium sized forms are able to continue to operate competitively.
Furthermore, unstable markets work to the advantage of smaller funds, who can focus on narrower fields exposed to market swings and also react more nimbly to shocks. These smaller hedge funds and investors will typically be catered to by smaller prime brokers. Accordingly, we can say that market volatility, which shows no sign of abating, and will increase further if geopolitical tensions continue to rise, will likely drive more funds to reap the benefits of smaller prime broker relationships. This trend will likely further be fed into by the increase in activist and green investment creating demand for niche investment funds, which itself will be catalysed as millennials and people from Generation Z grow their disposable income portfolios ready to invest.