When Prime Brokers Fail

An informative primer on the new landscape of leading prime brokers

Before the recent financial crisis, both regulators and market participants disregarded the complex and dangerous nature of the relationship between prime brokers (the banks) and their clients (the funds). In When Prime Brokers Fail, J. S. Aikman examines the convoluted structure of this relationship, the main participants, and the impact of the near collapse of prime brokerages on the financial world.

Filled with in-depth insights and expert advice, When Prime Brokers Fail takes a close look at the unheeded risks of prime finance and lays out the steps required for managers to protect their funds and bankers to protect their brokerages.

• Examines the challenges, trends, and risks within the prime brokerage space
• Discusses the structural adjustments firms will need to make to avoid similar disasters
• Analyzes the complex relationship between hedge funds and their brokerages and the risks that multiply in extraordinary markets
• Covers new ways to manage an inherently risky business and the regulations that may soon be introduced into this arena

Engaging and informative, this timely book details the intricacies and interdependencies of prime brokerages and the role that these operations play in our increasingly dynamic financial system.

Acknowledgments ix

PART I The Business

Chapter 1 Extraordinary Markets 3

Chapter 2 Fundamentals of Prime Finance 27

Chapter 3 Strategy and Opportunity 41

PART II The Players

Chapter 4 Hedge Funds 55

Chapter 5 Hedge Fund Managers and Investment Advisers 99

Chapter 6 Prime Brokerages 117

Chapter 7 Prime Brokerage Business Model 135

Chapter 8 Securities Lending and Financing 165

Chapter 9 Executing Brokers 185

PART III The Risks and Rewards

Chapter 10 Life Cycles 199

Chapter 11 Risk Management 205

Chapter 12 Legal and Compliance Issues 213

Chapter 13 What the Future Holds 235

Appendix A Prime Broker List 255

Appendix B List of Securities Lenders 257

Appendix C Prime Broker Due Diligence Questionnaire 259

Appendix D Useful Links—Prime Finance 265

Bibliography 267

Glossary of Useful Terms 277

About the Author 281

Index 283

J. S. AIKMAN is a management consultant and lawyer advising managers and financial institutions. He also lectures on hedge funds and investment banking at the University of Toronto. Previously VP and counsel for a bulge-bracket investment bank in London, Aikman has broad international experience in alternative investments and has served as adviser to many successful entrepreneurial ventures. Aikman completed his MBA at Oxford University. He may be reached at ja@jsaikman.com. Managing New Risk in a New World

"Whether you have been in the business for twenty years or are just interested in how the machine really works, Aikman's book is a must-have."
—Stephen Burns, Director of Electronic Equity Trading, Wellington West Capital Markets

The collapse and sale of Bear Stearns in 2008 marked the beginning of a series of failures of financial institutions in what was to be the worst financial crisis since the Great Depression. Only a few months later came the bankruptcy of Lehman Brothers.

Prime brokerages attached to each of these investment banks were caught in a difficult position as clients—mostly hedge funds and institutional firms—attempted to withdraw and reclaim any assets stored at the failing firms. Many were unable to do so, and while assets were held in abeyance during bankruptcy proceedings, hedge funds struggled to manage increasingly risky and overleveraged bets with less liquid capital.

Before the crisis, both regulators and market participants disregarded the complex and dangerous nature of the relationship between prime brokers (the banks) and their clients (the funds). In When Prime Brokers Fail, J. S. Aikman examines the convoluted structure of this relationship, the main participants, and the impact of the near collapse of prime brokerages on the financial world. He also covers new ways to manage an inherently risky business, the structural adjustments firms will need to make to avoid similar disasters, and the inevitable regulation.

Managing New Risk in a New World

"Whether you have been in the business for twenty years or are just interested in how the machine really works, Aikman's book is a must-have." —STEPHEN BURNS, Director of Electronic Equity Trading, Wellington West Capital Markets

The collapse and sale of Bear Stearns in 2008 marked the beginning of a series of failures of financial institutions in what was to be the worst financial crisis since the Great Depression. Only a few months later came the bankruptcy of Lehman Brothers.

Prime brokerages attached to each of these investment banks were caught in a difficult position as clients—mostly hedge funds and institutional firms—attempted to withdraw and reclaim any assets stored at the failing firms. Many were unable to do so, and while assets were held in abeyance during bankruptcy proceedings, hedge funds struggled to manage increasingly risky and overleveraged bets with less liquid capital.

Before the crisis, both regulators and market participants disregarded the complex and dangerous nature of the relationship between prime brokers (the banks) and their clients (the funds). In When Prime Brokers Fail, J. S. Aikman examines the convoluted structure of this relationship, the main participants, and the impact of the near collapse of prime brokerages on the financial world. He also covers new ways to manage an inherently risky business, the structural adjustments firms will need to make to avoid similar disasters, and the inevitable regulation.