An agreement between a primary broker and an execution broker in which the principal broker provides primary brokerage services in accordance with the SEC`s primary brokerage no-action letter. Another central topic is the common market practice of making a new pledge – that is, the right of the prime broker to “reuse” clients` assets for their own purposes. When assets are re-owned, hedge funds lose ownership of those assets and have the contractual right to return those assets. In the event of the insolvency of a prime broker, hedge funds remain general unsecured creditors for these re-reaffirmed assets. In many cases, Lehman was not required to provide regular reports on assets that had been re-pledged. Hedge funds have therefore not been able to monitor and manage this particular aspect of their prime broker credit risk. Large institutions do not invest in the financial markets like you or me. Although we use a brokerage to occasionally buy or sell stocks or mutual funds, they trade regularly and often heavily. They also do more than just buy and sell for a long time; They also frequently sell stocks short, use options or use a number of different securities trading instruments. The 2007-2008 financial crisis led to significant changes in the market for first-rate brokerage services, as many brokers and banks were restructured and clients concerned about their credit risk to their prime brokers sought to diversify their exposure to counterparties by moving away from many of their historical primary or duplicate broker relationships. Today, large, blue-rate brokerage firms typically monitor risk within clients` portfolios using proprietary “risk-based” margin methods that represent the worst loss of a portfolio based on liquidity, concentration, ownership, macroeconomics, investment strategies and other portfolio risks. These risk scenarios typically include a defined set of stress test scenarios, rules that compensate for the risk between the theoretical gains and losses (P&L) of these stress test scenarios for products of a common sublier, and compensations between theoretical P&L groups based on correlations.
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