The Prime Brokerage Business for Equities and Now Crypto
Summary of Marc Rubinstein's "Prime Time in Crypto" article
Marc Rubinstein’s experience as a former hedge fund manager gives him deep knowledge of the finance industry making him a must-read for anyone who is interested in anything finance.
In this article, Marc sums up the prime brokerage business, how it started, the risks (remember Archegos Capital?) and its transition from stocks to crypto.
Check out my summary below:
Credit Suisse is exiting the prime brokerage business which they had for equities and Coinbase is entering the prime brokerage business for crypto.
The aggregate value of the world’s crypto assets surpassed $1 trillion for the first time recently.
The prime brokerage started out as a result of the increasing amount of hedge funds who were having difficulty tracking all of their accounts with all of their different brokers.
In response to this, prime brokers were setup to keep accurate daily records and make this whole process simpler.
Furman Selz pioneered this with a computerized portfolio tracking system that he created.
Goldman Sachs set up a prime brokerage business as well through a company called Global Security Services. It offers the following services: custody, bank account management, margin lending, stock lending, synthetic prime brokerage and hedging services.
Most of the money made in the prime brokerage business is made on the financing side based on the spread between what the hedge funds pay the prime brokerage to lend at and the rate that prime brokers pay for their cost of funding.
Prime brokers require their hedge fund clients to post margin and pledge their underlying positions as capital in order to manage risk in the event of their fund melting down like Archegos Capital did.
Credit Suisse lost $5.5 billion on their prime brokerage business following the Archegos fiasco, meanwhile, Archegos was only contributing $26 million in annual revenues.
Credit Suisse closed up their prime business after this.
So, what led to this fiasco?
Here is how Marc tells it:
"Credit Suisse's loss arose not because the business wasn’t low-risk, but because the firm performed it badly. Credit Suisse made the classic error that firms in the lending business are prone to – underwriting on the basis of competitive positioning rather than underlying risk. IN 2019, Credit Suisse managers agreed to lower Archegos’ standard swap margin rate after Archegos convinced them that ‘another prime broker offered lower margin rates.’ They lowered it from an average of 20% down to 7.5%, which Argechos confirmed was ‘pretty good’.”
The closure of Credit Suisse’s prime brokerage business, along with Nomura and Deutsche bank closing up their prime brokerage business as well, is creating more consolidation in the industry around the three biggest players - JP Morgan, Morgan Stanley and Goldman Sachs.
Crypto ownership isn’t as adopted as equity ownership is since as of 2020, only 4% of Americans owned crypto in 2020 according to a survey mentioned by Coinbase. This is compared to 15.2% stock ownership for households in 2019 which has very likely gone up since then.
As of November 12, 2021, institutional customers make up 72% of Coinbase’s trading volume according to Marc.
Also, according to Marc, retail makes up only 28% of Coinbase's trading volume, but 94% of its trading revenues.
And speaking of the prime brokerage business, Coinbase and Galaxy have now introduced a prime brokerage service for crypto just for their institutional clients.