What is a Hedge Fund Introducing Broker?
A hedge fund introducing broker is a brokerage firm that introduces clients to another brokerage firm, or clearing firm, for a flat fee or commission per transaction. The clearing firm has the custody to the introduced assets and handles all of the transactions. The introducing broker generally does not handle cash or securities for the client. Also, the statements that are generated by the clearing firm and sent to the customer are in the name of the clearing firm.
Benefits to an Introducing Broker?
An introducing brokerage firm has many value-added propositions. To list them, the potential clients receives:
- Access into larger houses
- Generally cheaper commission costs
- Improved internal structure
- Custody at larger houses
- Capital Introduction
A smaller hedge fund would generally have a tough time getting directly into the larger prime brokerage houses. There are minimum asset levels as well as minimum transaction volumes that must be met in order to be accepted. Obviously, this presents a problem if you are a smaller fund that just started trading whatever asset the fund is using. The only real choice that you may have is to use a discount brokerage or introducing brokerage. Many funds have been following the route of introducing brokerage, as it is tough to get institutional money with a low-level prime brokerage on your structure. This affects a lot of the smaller funds. Also, it is important to note that larger prime brokerages had many problems. For example, if you were a hedge fund with Lehman Brothers or Bear Stearns as your prime broker, it created numerous headaches when trying to take out capital from the fund.
Reduced commission prices are a value-added benefit to introducing brokers. For example, a smaller fund is not going to have anywhere near the leverage needed in a negotiation to get the best execution price. These prices are reserved for the largest clients that do the most volume. As an introduced brokerage client, you are viewed as part of the larger account. Thereby, receiving much better servicing and pricing as business is done in aggregate volume. You are never guaranteed a lower commission price when using an introducing broker, but you are far more likely than by going directly to the main prime broker.
Improved internal structure and custody at the larger houses, are two items that go hand-in-hand, with utilizing an introducing broker. The improved structure is a result of having the custody of the assets at a much larger brokerage house. It goes without saying that it is easier to comfort investors minds if the assets and statements are coming from a name-brand house. It makes it much easier to raise institutional assets as well, as institutional investors are much less likely to invest if the assets are held at a discount brokerage that does not have a strong balance sheet. There are some funds out there that have been successful using the cheapest shop on the block, however it is much more difficult on any hedge fund salesperson or manager to answer this criticism of structure.
Third party additions are the last value-added proposition of an introducing brokerage relationship. The first to consider is capital introduction. An introducing broker receives compensation from underlying trading done by the client. In return, the introducing broker sets up meetings for that client. All the while, the assets and trading are done by the larger firm at a discounted price. This is a win-win situation, and is a big selling angle for the introducing broker. Many of the introducing brokers also have developed their own trading platforms and research. This is extremely important if your trading strategy revolves around best execution and you are used to using a specific type of software. Also, if you are using general software and are now exposed to more advanced execution platforms.
This article was written by:
Ryan Conner, CAIA