Prime Broker
A prime broker is a large bank or financial firm that provides a bundle of services to hedge funds and other big investors — lending money and securities, clearing and settling trades, holding assets in custody and reporting. It is the hub of a fund's trading operations.
A hedge fund that shorts stocks, uses leverage and trades across many markets needs a partner to borrow from, settle trades with and keep its assets. That partner is the prime broker. Prime brokerage is a major business for investment banks — and a channel through which hedge fund losses can hit banks. This entry explains the services, the economics and the risks.
- Category
- Market Structure
- Reading time
- 3 min
- Also called
- Prime brokerage, Prime broker services, PB
- Updated
Prime brokers in plain words
Prime brokerage is a set of services offered by investment banks and other large financial institutions to hedge funds and other investment clients.1
Hedge funds use leverage, short positions and derivatives, which require borrowing money and securities.2
The prime broker supplies those loans and handles the trades behind the scenes.1
What a prime broker does, step by step
Custody
Holds the fund's securities and cash.
Margin lending
Lends money for leverage. See Leverage.
Securities lending
Locates stock to short. See Securities Lending.
Clearing and settlement
Processes trades from many brokers.
Reporting
Consolidated risk and position reports.
Capital introduction
Connects funds with investors.
Worked examples
Example 1 — Financing leverage
2.5× leverageA fund with $200m of capital buys $500m of stock using prime broker financing.
| Borrowed | $300m |
| Leverage | 2.5× |
Prime brokers supply the borrowing hedge funds need for leveraged strategies.2
Example 2 — Margin call
Collateral callThe fund's assets fall 15%; the prime broker requires more collateral.
| Loss on $500m | $75m |
| Equity left | $125m |
When losses mount, prime brokers can demand collateral or reduce financing. See Margin Call.
Example 3 — Borrowing stock to short
$200k a yearA fund shorts $20m of a stock; the borrow fee is 1% a year.
| Annual borrow cost | $200,000 |
Prime brokers locate and lend shares for short sales, for a fee. See Short Locate and Borrow Availability.
Prime broker vs retail broker
| Aspect | Prime broker | Retail broker |
|---|---|---|
| Clients | Hedge funds, institutions | Individuals |
| Services | Financing, lending, custody, clearing | Execution, basic margin |
| Leverage | Large, negotiated | Standard limits |
| See also | Investment banks | Discount and Full-Service Brokers |
Why prime brokers matter
Hedge fund operations
The backbone of trading. See Hedge Fund.
Short selling
Borrowing shares. See Short Selling.
Systemic risk
Fund failures can hit banks. See Systematic and Systemic Risk.
Bank revenue
Financing and lending fees.
Advantages and disadvantages
Advantages
- One-stop service for complex funds.
- Access to leverage and stock loan.
- Consolidated reporting.
Disadvantages
- Concentration risk if a prime broker fails.
- Financing can be pulled in stress.
- Exposes banks to hedge fund losses.
Going deeper
Read as far as you need. Each level builds on the one before it.
Who provides it
Beginner
Prime brokerage is offered by investment banks and other large financial institutions.1
Rehypothecation
Intermediate
Prime brokers may reuse clients' collateral for their own funding, which can cause problems if the broker fails. See Rehypothecation.
Multi-prime
Advanced
Large funds often use several prime brokers to reduce counterparty risk, though this can hide total leverage from each one. See Counterparty Risk.
Common mistakes
Assuming financing is permanent
Terms can tighten fast.
Ignoring counterparty risk
Prime brokers can fail too.
Underestimating borrow costs
Hard-to-borrow stocks are expensive.
Concentrating with one PB
Diversify relationships.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Prime brokers serve hedge funds and large investors.
- They provide financing, stock loans, custody and clearing.
- They enable leverage and short selling.
- They can demand collateral in stress.
- They link hedge fund risk to banks.
Frequently asked questions
Can individuals use a prime broker?
Why do hedge funds need prime brokers?
What happens if a prime broker fails?
Further learning
- Hedge Fund
The main client.
- Securities Lending
Borrowing shares.
- Margin Call
When financing tightens.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Prime Brokerage (opens in a new tab) Checked .
- Corporate Finance Institute. Hedge Fund (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.