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Hi Rajasimha,

Synthetic Prime Brokerage :

A specialized brokerage service for clients who need non-standard services. Such service consists of clearing, custody, Equity Finance and financing arrangements.

There are two major methods that a prime broker can lend leverage to a hedge fund. The first is by providing margin financing; in other words, the hedge fund borrows some portion of the security's value from the prime broker. For example, the hedge fund holds a portfolio with a value of $100 million, using $25 million of its own assets and $75 million of margin debt provided by the prime broker. This way the hedge fund achieves a leverage of 4 to 1 (assuming only long positions), and the prime broker gains interest on the debt.

The alternative way of extending leverage is through the OTC derivatives. While the structure of this form of financing varies, one approach takes the form of a managed account swap, and is usually termed "synthetic prime brokerage". The prime broker sets up an account advised (or managed) by hedge fund manager who has trading discretion. So different from the first method, in this case even though hedge fund manager trades the account to implement the hedge fund's strategy, the portfolio actually belongs to the prime broker. The prime broker then enters into a total return swap with the hedge fund, and charges the interest in the form of a swap payment received from the hedge fund.

Through this synthetic prime brokerage service, the leverage used by the fund is determined by the amount of margin on the swap required by the prime broker. To follow the example above, the prime broker has an account with $100 million of its own assets. The account is advised by the hedge fund manager, where the hedge fund is the counter-party to a total return swap on that account. As margin for the swap, the prime broker requires the hedge fund to post $25 million of equity; thereby providing leverage of 4 to 1.

Many hedge funds use synthetic prime brokerage service as part of a full service prime brokerage agreement - with equity swaps used side by side with stock loan and other services for particular parts of their portfolios.

I am hoping this is useful.

Gaurav Shah

Links:

• http://www.de-conseil.com/
• http://www.de-conseil.com/dg_press.asp

posted December 25, 2009

It's a service used to help hedge funds lower their overall PB costs via swap and derivative products.

posted December 22, 2009