They may also offer capital introduction services for the hedge fund’s manager. Capital introduction is essentially the process of connecting hedge fund managers to potential investors in the form of the prime broker’s asset management and private banking clients. Prime brokers further serve their hedge fund clients, who frequently engage in trading derivative financial instruments, by offering them access to their derivatives trading desks along with risk management suggestions from their own derivatives trading operations. In addition to lending either securities or cash, prime hedge fund custodian brokers also offer a number of concierge services to their hedge fund clients. “Capital introduction,” for example, is provided by dedicated teams within a prime broker to assist new funds in identifying potential investors.

What Is a Mutual Fund Custodian?

• Client money and asset protectionTwo significant new rules in relation to the protection of client money and assets have been introduced.
• A prime broker is a central broker through whom the fund executes most or all of its trades and who typically acts as custodian of the fund’s assets.
• The Judge identified “red flags” that ought to have been obvious to service providers in dealing with a high operational risk business model and provided helpful guidance on the scope of obligations owed by administrators and custodians, which are summarised below.
• They serve as an additional layer of security, safely holding a mutual fund’s portfolio, managing record-keeping, and helping reduce the possibility of fraud.
• If a manager is deemed to have custody, the manager will generally need to follow certain safe-keeping requirements.

As with more traditional offerings, participation in any of the concierge services is optional. The Securities and Exchange Commission (SEC) has specific rules and requirements governing the custody of mutual funds, outlined primarily in Rule 206(4)-2 of the Investment Advisers Act of 1940. These regulations, revised in 2009 to improve transparency and investment safety, aim to mitigate the risks of fraud by https://www.xcritical.com/ investment companies and fund managers.

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The Federal Reserve is monitoring the processing of OTC derivatives closely, and are working with the financial services industry to ensure that infrastructure is not only scalable and efficient, but that it also manages operational risk effectively. The need to reduce confirmation backlogs puts the responsibility back on fund managers and their designated custodians to work together. The custodian community and fund managers continue to work toward operating in a Straight-through Processing (STP) environment in order to mitigate risks. Regulators have rightfully highlighted the importance of utilization of electronic trade confirmation platforms as being fundamental to risk management.

What Is the Difference Between a Custodian and a Fund Manager?

Prime brokers will also be required, from 1st March 2011, to provide detailed daily reports to their clients which are to include comprehensive details of the client’s assets and financing obligations in relation to the prime broker. Many global financial firms offer custody services for all types of investments, including stocks, bonds, mutual funds, and exchange-traded funds. Fidelity, a federally regulated bank holding company, often acts as its own custodian. Selecting the right prime broker is always a very important decision for a hedge fund manager, regardless of whether they are a new start-up or a multi-billion dollar fund closed to further investments.

In practice, however, the results of these matchmaking services can be highly varied. At the very least, these services can expedite the fundraising process for strategies and individual principals currently favoured by the market. Although in recent years prime brokers have expanded their services to include risk management and capital introduction, securities and cash financing remains their core (and most profitable) services. In addition to execution and custody services, a prime broker provides hedge funds with the ability to borrow stocks and bonds (known as “securities lending”) and to borrow money to buy stocks and bonds (known as “margin financing capabilities”). Nonetheless, hedge funds are turning to custodians to supplement – rather than replace – the services already provided to them by their existing prime brokers. While hedge funds are important to prime brokers’ business, other large investment clients that need clearing services, or to be able to borrow securities or cash in order to engage in trading would also need a prime broker.

While lending cash is a commodity service with a transparent cost structure, lending securities is not. Capital Fund Law Group has authored numerous investment fund publications, including instructive eBooks, white papers, blog posts, and sample offering document excerpts with illustrative footnotes. These complimentary downloads are dedicated to helping fund managers understand the legal fundamentals of launching and operating an investment fund. Potential investors in a hedge fund may also be influenced by the selection of a particular prime broker—either positively or negatively.

In essence, a prime brokerage service gives large institutions a mechanism allowing them to outsource many of their investment activities and shift focus onto investment goals and strategy. Bank custodians like UMB may also be able to support alternative managers even further throughout the investment lifecycle with traditional banking and escrow services, investor servicing and fund administration. Clients are also privy to the prime broker’s private research services, thus enhancing and reducing the fund’s research costs. Outsourced administration and trustee services, along with enhanced leverage enabled by offering lines of credit, are additional features offered by many prime brokerage firms. This exemption may cease to be available however if the private placement regimes are phased out from 2018.

In this article, we focus on the role of prime brokers and how large investment clients choose the right one. A true custodian bank would have assets under custody separate from the bank’s balance sheet and maintained as distinct from bank assets not subject to bank creditors. Assets under custody by a qualified custodian are different and should not be construed as a bank deposit and/or brokerage account. Protection against bankruptcy or insolvency of the adviser or custodian is established by segregating the assets and identifying them as being held on the client’s behalf. A prime brokerage is a bundled group of services that investment banks and other financial institutions offer to hedge funds and other large investment clients. They often need to be able to borrow securities or cash to engage in netting, which offsets the value of multiple positions or payments exchanged between two or more parties.

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They serve as an additional layer of security, safely holding a mutual fund’s portfolio, managing record-keeping, and helping reduce the possibility of fraud. A custodian is a specialized financial institution (typically, a regulated entity with granted authority like a bank) that holds customers’ securities for safekeeping in order to minimize the risk of their misappropriation, misuse, theft, and/or loss. A prime brokerage generates revenue in a few different ways, including overall fees, commissions on transactions, and lending charges. They also charge different rates depending on the volume of transactions a client does, the number of services a client uses, and so on. Another investor-related area—one which we’ve seen significant interest—is help completing alternative investment subscription documents on a manager’s behalf. This can include completing the core offering documents as well as AML and KYC requirements for each investor.

Custodian banks are depository institutions, meaning they have to comply with Federal Reserve standards and possess the proven infrastructure for all non-negotiable requirements based on federally mandated wiring protocols. As the funds landscape continues to evolve, custody is increasingly becoming a value-adding function for hedge fund and liquid alternative managers’ distribution and investment growth strategies. BNP Paribas Securities Services looks at the drivers behind this – together with some of the criteria which hedge funds should consider when selecting their custodians. For hedge funds or other institutional clients to get the kind of services that make having a prime brokerage account worthwhile (most notably discounted fees for trading), an account size of $50 million in equity is a likely starting point. Where assets held in custody are lost, the depository is obliged to return identical financial instruments or the corresponding amount to the fund or the manager acting on behalf of the fund without undue delay.

Bank customers should be familiar with such activities and the products that represent them. The difference between custodian banks and traditional banks is their primary roles. Item 15 of Form ADV Part 2 (the Brochure) requires additional disclosures for those managers who have instructed qualified custodians to send account statements directly to the investors. For more information read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD). Alternatively, please contact IB Customer Service to receive a copy of the ODD.

Against a backdrop of shifting regulation, rising allocation, and convergence across strategies, the strategic value that custodians can add is increasingly coming into focus. For hedge fund and liquid alternative managers, the right custodian can enable growth strategies via additional yield generation, cash optimisation, hedging, financing, and distribution benefits. Beyond the pivot towards illiquids, client demand and regulatory pressure is resulting in more hedge funds embracing ESG (Environmental, Social, Governance) – and this is something service providers need to accommodate for.

These differences are important for prospective investors to bear in mind before they sign on the dotted line and send in their checks. A prime broker’s relationship with a hedge fund, and its ability in the long term to profit from that relationship, can be very different from the experience that investors actually have in the same hedge fund. Among the primary considerations in selecting a prime broker are the price of the various services offered, easy access to large holders of securities, including holders of less liquid and more difficult-to-borrow securities, and trading confidentiality. A traditional bank may also offer custody services and therefore function as a custodian bank as well.