Prime Brokerage

An executing broker sends a give-up notice to a customer's prime broker for a trade executed under a prime brokerage arrangement. The prime broker has not yet accepted the trade. Who is responsible for settlement of the trade at this point?

1. A.No one, since an unaccepted give-up means the trade has no settlement obligation until the prime broker responds.Wrong. The trade still has a settlement obligation; it simply has not yet transferred away from the executing broker.
2. B.The executing broker, because settlement responsibility does not shift to the prime broker until the prime broker accepts the give-up.Correct. Acceptance is the gate; before it occurs, the executing broker remains on the hook for settlement of the trade it executed.
3. C.The prime broker, because the prime brokerage agreement automatically assigns settlement responsibility for every trade the customer executes, regardless of acceptance.Wrong. Responsibility does not shift automatically at execution; acceptance of the give-up is what completes the transfer.
4. D.The customer directly, since prime brokerage relationships exist to remove settlement responsibility from both brokers entirely.Wrong. Settlement responsibility sits with one of the two brokers at any given point, not directly with the underlying customer.

Why: Acceptance of the give-up is the gate that transfers settlement responsibility. Until the prime broker actually accepts, the executing broker retains settlement responsibility for the trade it executed, even though the trade was intended for the customer's prime brokerage account.

A customer wants to establish a prime brokerage arrangement, executing trades through multiple executing brokers but settling and custodying everything through a single prime broker. What must be established before this arrangement functions operationally?

1. A.A prime brokerage agreement among the customer, the prime broker, and each executing broker, along with notice to the executing brokers of the prime brokerage relationship so they know to give up the trades to the prime broker rather than settling directly with the customer.Correct. A prime brokerage agreement plus notice to executing brokers is required for the arrangement to function.
2. B.Nothing beyond the customer's ordinary new account paperwork at the prime broker; executing brokers need no separate notice or agreement to participate.Wrong. Executing brokers need notice of the prime brokerage relationship for the give-up process to function.
3. C.A single executing broker must be selected exclusively, since prime brokerage arrangements do not permit trading through more than one executing broker.Wrong. Prime brokerage arrangements specifically allow trading through multiple executing brokers while settling through one prime broker.
4. D.The prime broker must itself execute every trade directly, since prime brokerage arrangements do not involve separate executing brokers at all.Wrong. Prime brokerage arrangements specifically involve separate executing brokers, with the prime broker handling settlement and custody.

Why: A prime brokerage arrangement depends on every party involved understanding its role: the prime broker agrees to settle and custody the customer's positions, while each executing broker the customer trades through needs to know it should give up those trades to the prime broker rather than settling directly with the customer itself. This requires both a formal prime brokerage agreement establishing the arrangement and notice to each executing broker so the give-up process actually functions as intended.

An institutional customer executes through several executing brokers but settles everything through one prime broker, which has accepted the trades. One executing broker completes a purchase for the customer. Where does that position settle?

1. A.Each executing broker settles with the custodian of the customer, and the prime broker consolidates positions for reporting only.Wrong. That describes a delivery-versus-payment relationship with a custodian bank, not a prime brokerage arrangement.
2. B.The executing broker settles with the prime broker only if the prime broker declines the trade; otherwise it settles with the customer.Wrong. This reverses the consequences of acceptance and rejection.
3. C.The prime broker settles the trade into its own error account until the customer confirms the instruction.Wrong. An error account exists for mistakes the firm itself made and has no role in an accepted give-up.
4. D.The trade is given up to the prime broker, which settles it and books the position in the prime brokerage account.Correct. Acceptance makes the prime broker the settlement counterparty of the executing firm and the single point of custody for the customer.

Why: Under a prime brokerage arrangement the executing brokers give up their trades to the prime broker, which becomes the settlement counterparty to the executing broker and books the resulting position in the customer account at the prime broker. That is the point of the arrangement: the customer can execute wherever it gets the best result and still hold one consolidated position, one margin calculation and one statement. If the prime broker declines the trade, it reverts to the executing broker, which then settles it with the customer directly.

Fairhaven Clearing acts as prime broker for a fund that executes through four other broker-dealers. A new settlement clerk asks whose books carry the fund's positions and cash, and which firm produces the fund's account statement. What is the answer?

1. A.Each executing broker carries and statements what it executed; the prime broker only reconciles.Wrong. That describes a fund running four separate brokerage relationships, which is the arrangement prime brokerage was invented to replace.
2. B.The prime broker holds the cash while each executing broker holds the securities it bought.Wrong. Splitting an account by asset class across firms would make it impossible to margin the positions against the cash in one place.
3. C.The prime broker carries the positions and cash and issues the consolidated statement.Correct. Centralizing custody, financing and reporting at one firm while execution is spread around is exactly what the arrangement is built to do.
4. D.The positions are registered in the fund's own name at the depository.Wrong. Direct registration takes securities out of street name, which is incompatible with a prime broker financing and lending against them.

Why: In a prime brokerage arrangement the customer keeps one account holding everything, positions, cash, margin and financing, at the prime broker, and separate accounts at executing brokers that exist only to execute. Trades done away are given up to the prime broker, which clears and settles them into that single account and produces one statement covering all of it. The customer therefore sees consolidated books and a single margin computation, which is the commercial reason the structure exists. If the trades were not given up, each executing broker would have to clear and carry what it executed and the customer would be back to four separate relationships.