Prime broker

A prime broker is a division of a large bank that provides hedge funds and other large trading clients with a bundle of services needed to run a leveraged trading operation, most importantly financing, margin lending, and securities lending for short selling. Rather than a hedge fund arranging financing, custody, and stock borrowing separately with different counterparties, a prime broker packages these functions together.

Prime brokers lend hedge funds cash to increase their buying power and lend out shares that clients need to borrow when they want to short a stock, charging fees and interest for both. They also hold custody of a fund's assets, handle trade settlement, and often provide capital introduction services, connecting a hedge fund with potential investors.

The relationship between a hedge fund and its prime broker is central to how much leverage that fund can use and how it survives stress. When a hedge fund runs into trouble, its prime brokers can demand more margin or cut off financing, which can force the fund to sell positions quickly. Because a handful of large banks dominate the prime brokerage business, problems at one major prime broker, or at a large client, can ripple through the financial system, as seen when the collapse of a large, highly leveraged family office client caused sudden losses at several major banks in 2021.