Finadium: Prime Brokerage: Towards a New Target Operating Model for Financing

This Finadium report looks at a newly emerging conversation in prime brokerage on the Target Operating Model for financing. We evaluate the historical prime brokerage financing model in relation to new regulations, segmentation in prime brokerage and what a securities financing exchange may look like compared to existing market models. Our findings are the result of recent conversations with prime brokers, hedge funds and service providers. The report also benefits from conversations at recent Finadium conferences and panels.

For prime brokers, the new name of the game is balance sheet. This is well-traveled information. The more complex issue is how to get there and what will be the most profitable routes to offer hedge fund clients financing in the future. This briefing highlights a new Target Operating Model for prime brokerage financing that appears to be growing in popularity, at least conceptually, across the industry. In practice, some newer entrants to the market are already there while others have some work ahead of them to change their strategy and be ready for the post Basel III era.

The old operating model was convenient: match as many margin positions and securities loans as possible internally and take a spread in the middle. As one example, Bear Stearns had a highly profitable run from 2002 to 2006: client balances across margin positions, short positions and free credit balances increased by 70% while interest revenue rose by 93%.

In 2015, the desire to match client margin and short selling balances is still highly evident but the cost has gone up. New internal liquidity costs have increased profitability hurdles for prime brokers, pushing more divisions to be self-financing and less reliant on their central treasuries.

This report is part of the Finadium Executive Briefing series, providing briefings and analysis to the financial markets industry. Finadium Executive Briefing and Finadium full research subscribers can log in to access this report.

For non-subscribers, more information on this report and subscription information is available on the Finadium website.

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