Prime Broker vs. Executing Broker

December 16, 2016

Like in the banking industry, the brokerage industry has special services dedicated to special clients. These services are offered exclusively to these clients and are not part of the regular offer the brokerage house has. Such a brokerage house is being called a prime brokerage.


The Role of the Prime Brokerage

Most of the large brokers, like Goldman Sachs, Morgan Stanley, etc., are offering services like leverage trade executions or cash management to special clients. The clients that fit into this category have a bigger trade account and that normal and move important amounts of money.

Therefore, they need special attention and special conditions. Just to give you an example, try move on hundred lots trade multiple times a day with a regular retail broker and you’ll be contacted immediately by that respective brokerage house.

The reason for that is the fact that if you’re able to trade in such a size, you probably belong to a group of people that needs prime brokerage attention. Prime brokerage houses offer a series of resources other brokers miss. The need for such services grew bigger and bigger by the time the hedge fund industry expanded more and more in the last years.

Clients in this category are big-time investors and institutions, money managers, hedge funds, etc. In general, traders that are moving large amounts of money are subject to prime brokerage services.

These services are vital for the success or failure of a hedge fund, as reducing costs associated with trading is a goal all funds have. Pension funds, treasury departments of commercial banks and any other large institutional investors are part of these services.

In short, the main role of a prime brokerage is to give large traders and institutions the possibility of outsourcing part of their activities, in turn of a fee. This way, the investment vehicle can focus on the overall investment, and the brokerage house earns a fee for the services offered.


What are Executing Brokers

Still, in the same area of dealing with large institutional clients, executing brokers play an important role. Such a broker is effectively one that submits the orders on behalf of a client. In short, it is taking care of the effective trading, carrying out the order.

The role of executing brokers is quite important as often hedge fund managers are working with one brokerage house as a prime broker that offers a bundle of consolidating services and other brokers as executing ones, being instructed to buy or sell with the prime broker. Considering the fact that executing brokers are earning from commissions, conflicts of interests may appear from time to time. Nevertheless, a well-organized hedge fund will always find it more appealing to deal with trading through a prime broker and a bunch of executing ones for clearing as this way reporting is easy to be made as all things are being kept together.

Prime brokerage is strongly linked to the hedge fund industry as mentioned above and the changes in the industry affect the brokerage houses as well. Technology changes make keeping up with the developments in the industry quite a daring task.

For that reason, and not only, prime brokers provide centralized clearing facilities, while executing brokers settle their trades there. Commissions in terms of spreads are being charged, as well as other associated costs for additional services.

All in all, the bigger the fund the bigger the need to deal with more and more leveraging, and by leveraging one should not consider only the actual size of the investments, but also the number of brokers the trade execution process is made. A hedge fund’s success depends very much on it.

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