prime brokerages
6 March 2024

Updating Prime Brokerage Margin Models: The Need for Transparency and Real-Time Risk Management

Vardaan Kohli
Senior Product Speci

The prime financing sector has undergone significant transformation in recent years. Market cycles, shifts in monetary policy, bad actors (Archegos), and geopolitical events have influenced risk and revenue dynamics. Rising interest rates have increased benchmark financing costs, negatively affecting buy-side entities dependent on affordable leverage yet benefiting prime financing providers..


The departure of high-profile market participants such as Deutsche Bank and Credit Suisse, has also created opportunities for smaller entities in the prime financing domain. New, tech-savvy entrants with limited capabilities in execution but, with lower operating costs (e.g. balance sheet) than traditional Prime Brokers, are in growth mode with a strong emphasis on developing synthetic prime platforms.

Meanwhile, on the buy-side, an increasing number of single-manager hedge funds have either migrated or are in the process of migrating to multi-manager models, with a new set of considerations arising about the allocation of trading and capital costs at newly defined risk/pod levels. Cost allocations are key foundations to this business model – funding costs associated with generating P&L require closer analysis than in a single manager structure. By extension, multi-managers are increasingly incentivized to minimize external margin costs while charging back standalone funding requirements internally, excluding offsets, or in other words creating a treasury profit center. This requirement has led to a more strategic approach to apportioning fair cost allocation to granular risk pod levels. 


In their role as lenders, Prime Brokers (PBs) are navigating a landscape marked by heightened competition from emerging market participants and the looming threat of defaults by hedge funds. 


In this commentary article, Vardaan Kohli, product specialist at Cassini, discusses the need for updated prime brokerage technology solutions to monitor real-time margin movements to efficiently manage risk while providing hedge fund clients with enhanced transparency designed to enable a more seamless cost pass-through model to underlying manager or strategy levels.


In prime brokerage, effectively managing risk is critical to safeguarding against losses from counterparty defaults. The extent to which a prime broker extends credit to a hedge fund is determined by the fund’s asset quality and its counterparty risk profile. Prime brokers must utilize sophisticated models or frameworks for these assessments, moving beyond the manual or outdated methods. The technology employed, whether developed in-house or sourced externally, must not only be robust but also flexible, accommodating the dynamic requirements of the hedge fund market and the wider clientele they cater to. 

Margin Transparency is Key for the Prime Brokerages’ Hedge Fund Clients

Transparent margin practices are crucial for hedge fund clients within the prime brokerage sector. Providing detailed insights into margin calculations, requirements, and the factors influencing them enables hedge funds to better manage their leverage and risk exposure. Such transparency fosters trust and facilitates more informed decision-making by hedge funds, aligning with their strategies and financial goals.

Predominantly, margin models used by exchanges and clearinghouses are based on Value-At-Risk (VAR). However, recent events such as the COVID-19 pandemic, the war in Ukraine, and the ensuing energy crisis have led to a significant increase in margin requirements across all asset classes. Concurrently, rising interest rates have escalated the cost of the collateral required by hedge funds to post, placing additional financial pressure on these funds.

Hedge funds prioritize transparency from prime brokers concerning margin requirements and the availability of tools and resources to verify the brokers’ actions. When allocating new exposures or adjusting existing balances across counterparties, hedge funds require precise information to make informed decisions.


Meanwhile, in the competitive landscape of prime brokerage, maintaining client satisfaction while effectively managing various risks—operational, regulatory, market, or counterparty—is paramount. The ability to evaluate and respond to evolving risks promptly is crucial. Prime brokers must leverage advanced technology to minimize operational risks and enhance their decision-making processes, ensuring agility in adapting to market changes and safeguarding against manual process vulnerabilities. 

Managing Margin Calls with Real-Time Risk Assessment

Prime brokers engage in a daily regime to oversee margin calls, requiring a continuous assessment of whether clients have satisfied these calls, the evolution of their positions throughout the day, their trading activities, and the impact of market price fluctuations on margin requirements. It’s imperative for prime brokers to proactively monitor their clients’ positions and portfolio levels in real-time, staying alert to any market shifts that could deteriorate their clients’ creditworthiness and increase the risk of default, which could, in turn, impact the brokers’ revenue.

Furthermore, regulatory mandates restrict prime brokers from extending excessive leverage to their clients, necessitating technology that offers a near-real-time overview of risk exposure across all clients. Prime brokers must deploy sophisticated technological solutions that not only facilitate accurate margin calculations, trade bookings, and pricing but also ensure efficient communication with relevant teams about the potential impacts of these activities. Beyond regulatory compliance, the efficiency of systems and processes is vital for enabling timely corrective or preventative measures.


Having a technology resource that both parties can use and rely on gives hedge fund clients confidence in the prime broker’s margin models.

The Importance of Robust Prime Brokerage Margin Models

Hedge funds understand the necessity of higher margins but prioritize confidence in their prime brokerage’s risk management capabilities and long-term viability. A stable and reliable margin model from the prime broker fosters this trust, encouraging hedge funds to potentially increase their engagement. The key is the consistency of the margin model, which should not fluctuate wildly day-to-day, allowing hedge funds to strategize their investments and operational decisions more effectively.

Access to advanced technological resources that both hedge funds and prime brokers trust can enhance this confidence, especially in the robustness of the prime broker’s margin models. Prime brokers conduct regular stress tests to evaluate the efficiency of the margin charged and to identify any concentration risks within their client portfolios. This includes assessing the impact of market movements across different sectors, countries, stocks, or interest rates on margin requirements.

Should these stress tests reveal inefficiencies in how margin is applied, prime brokers may consult with their clients to adjust collateral requirements, modify portfolio compositions, or update margin policies accordingly.

Given the high cost of collateral in the current market, hedge funds might be cautious about maintaining excess cash with a prime broker. Thus, proactive planning and optimization of collateral usage, informed by stress test outcomes, are beneficial for both parties.


Prime Broker Tools for Boosting Collateral Resiliency

Prime brokers, often integral parts of broader banking entities, benefit from centralized functions and the holistic risk management capabilities of their larger institutional framework. This integrated approach allows for comprehensive liquidity analysis, firm-wide stress testing, and robust collateral management. An advanced margin management tool, connected to this broader infrastructure, streamlines margin processes and workflows, offering dynamic and flexible solutions. It enables the seamless sharing of margin-related insights across various internal systems, aiding in collateral management and liquidity stress testing.

On the hedge fund side, larger entities typically possess technological capabilities on par with major banks, enabling effective collateral resilience analysis, comprehensive stress testing, and margin forecasting. They can also optimize collateral to free up excess capital for various trading activities. However, smaller hedge funds may not have the resources to perform these functions comprehensively. For these smaller entities, adopting external technology solutions that emulate the capabilities of larger banks can be a strategic move, offering significant advantages without substantial internal investment.

This approach allows smaller hedge funds to level the playing field, enhancing their risk management and operational efficiency by leveraging technological advancements akin to those used by their larger counterparts and prime brokers.
Providing clarity around their margin models enables prime brokers to be transparent with their hedge fund client base and provide clients with what they need to estimate their margin requirements.

Long-Term Advantages of Updating Margin Models and Providing Transparency

By enhancing their technological capabilities, prime brokers can offer greater transparency regarding margin models, fostering stronger, long-term relationships with their hedge fund clients. Hedge funds value clarity on their margin status, as it directly impacts their decision to continue or expand business with a prime broker.

However, the underlying motive for prime brokers is risk management. Operating on an asset-based lending model, prime brokers aim to maximize the leverage extended to hedge funds at minimal costs. Achieving this balance relies heavily on advanced technology, which facilitates efficient execution and flexibility.

The use of cutting-edge technology allows prime brokers to have a real-time overview of assets and hedge fund balances, enabling strategic lending decisions and asset optimization. This not only enhances revenue opportunities but also strengthens client relationships by improving the efficiency of margin and risk management processes, all without compromising the prime broker’s risk profile.

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