The term Prime Brokerage gets thrown around a lot, but many people dont fully understand what is meant by the term. Prime brokerage is a generic term for a package of services offered by major investment banks to hedge funds, broker dealers and other large professional investors. Typically prime brokerages offer a number of services to their clients, with the majority of prime brokerages offering custodial services, financing & lending, technological solutions and other forms of operational support. Some prime brokerages will also offer other value added services which may include risk management advice, capital introduction and other consultancy services.
Prime brokerages turn a profit by charging financing fees on the clients leveraged positions and may additionally charge clients for other back office services. Hedge funds will often use prime brokerage services as it means they can outsource a lot of their back office operations out to the prime brokerage.
The fact that Forex is an over-the-counter interbank market means that prime Brokerages fulfil a very important role. The over-the-counter nature of the market place introduces significant counterparty risk, as there is always the possibility that the other the side of the trade will go bankrupt and be unable to fulfil their obligations. Determining the credit worthiness of counterparties can be costly and difficult meaning that many major liquidity providers will limit who they do business with. For instance the largest liquidity providers in the Foreign exchange market are unlikely to do business with smaller operators. Prime brokerages fill this gap by allowing small players to access the liquidity offered by the biggest banks and institutions through the use of a prime brokerage service, as it is the prime brokerage which acts as the counter party to the individuals or institutions trades.
You will find many smaller retail Forex brokerages making use of prime brokerage services, as it will allow them to tap into pools of liquidity which would otherwise be out of bounds. This extra liquidity will often result in lower spreads and reduced slippage. A number of prime brokerages will offer their services to individual clients but may require they client has at least several hundred thousand dollars deposited with the firm. This means that prime brokerages are not an option for the vast majority of individual traders. As many brokerages make use of prime services retail traders may be still able to gain access to the liquidity offered by these prime brokerages albeit with a marked-up spread.
A number of big name banks offer prime brokerage services and those interested in using a prime brokerage service should get directly into contact with these firms, who will be able to layout the terms and the minimum capital required to begin trading using their prime services. For those who do not have the capital required to open a prime brokerage account, STP/ECN brokerages may make for a good alternative.
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