A prime broker is a central broker through whom the fund executes most or all of its trades and who typically acts as custodian to the fund’s assets. When the hedge fund executes trades through other brokers, the prime broker works with the executing brokers to settle and transfer all assets through the prime broker.
This custodial relationship facilitates simpler reporting of the fund’s positions (which in turn simplifies the work of the administrator and auditor) and allows the prime broker to use all of the fund’s assets for margin purposes. Prime brokers typically provide interactive trading platforms with extensive capabilities. In addition to custodial services, prime brokers can provide leverage and margin, facilitate short sales, provide soft dollar arrangements, perform portfolio analysis, stress testing and other services.
Most prime brokers are large Wall-Street institutions that are generally not able to service a hedge fund until it reaches a substantial threshold of assets under management. However, mini-prime brokers or “introducing brokers” act as a liaison between a hedge fund and the large prime broker. Introducing brokers provide startup fund managers access to the full range of services provided by prime brokers.
Most startup hedge funds begin their fund with an introducing broker. Your hedge fund attorney can suggest introducing brokers and custodians.
Note that for most startup hedge fund, the prime broker typically acts as the custodian. However, the role of custodian and prime broker are often performed by separate service providers, often to mitigate risk.
INSTRUCTIVE RESOURCES
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Forming and Operating a Hedge Fund | an eBook
Written by the managing partner of Capital Fund Law Group, Forming and Operating a Hedge Fund provides an in-depth guide to assist emerging hedge fund managers through the process of successfully structuring, launching, and raising capital for a domestic or offshore hedge fund. Throughout the eBook, it highlights pitfalls that fund sponsors should watch for and suggests best practices to safely and effectively navigate the process of forming and operating a hedge fund.
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Capital Fund Law Group is a boutique investment law firm focused on advising emerging and established investment funds on all aspects of formation and operation. We provide predictable flat-fee services for most of our engagements. Our legal team has extensive experience advising hedge funds, real estate funds and private equity funds throughout the United States in various structures and strategies. We also prepare debt and equity private placement offerings for companies in all major industry sectors.
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