Finadium: How Prime Brokers Price Their Hedge Fund Clients

This report offers a primer on how prime brokers price their clients and a sample Excel spreadsheet that leveraged funds can use to model their own exposure. The Excel model presents options for a US cash prime broker client and a European synthetic financing client. While every leveraged fund has different portfolio and financing needs, the model serves as a starting point and can be adapted and expanded on for customization.

The prime brokerage market is led by large global systemically important banks, or GSIBs, giving them common traits in how they approach the financing of their hedge fund clients. They also share similar constraints in balance sheet management owing to the financial resource regulations by which they must all abide. For hedge fund clients, understanding the drivers of GSIBs in balance sheet management directly contributes to P&L on the financing desk, estimated at anywhere between 50 and 150 bps annually, according to Finadium research. Being a smart hedge fund client means making more money for the firm and its investors.

Today’s prime brokers are data-driven, enabling them to analyze, calculate and attribute their financial resource utilization to the activity of each client, a complex yet important piece of work that ensures an optimal Return on Assets (ROA). Internal bank divisions and their clients are engaged in competition for a finite amount of financial resources: ROA stands as one measure of best deployment. This includes making as much revenue as possible that utilizes no funding or balance sheet (the dream trade). This may include execution, back-to-back derivative positions or leveraging the balance sheet through refinancing and reuse of assets.

The models that prime brokers use to price their hedge fund clients have become increasingly standardized in recent years, the result of Basel III regulations and internal directives for ROA. Profitability has always mattered, but the dual focus on both profitability and balance sheet management may not always be clear on the client side. As a result, hedge funds and other leveraged clients should have a solid understanding of prime brokerage pricing models in order to be a good client. Both funds and their prime brokers will benefit from this education.

Expected readers of this report include hedge funds and other leveraged fund managers in leadership positions and in the treasury or portfolio finance function. Funds with less experience in portfolio finance may benefit from the introductory sections, while more experienced professionals may turn directly to the discussion of the Excel model and the model itself, available on the Finadium website alongside this report document.

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