For the past two years, the prime brokerage industry has undergone a major transformation in response to the financial crisis. Hedge funds have adjusted their business model in order to diversify counterparty risk, causing prime brokerages to adjust their services and offerings. This, in turn, has opened new opportunities and caused a reorganization in the business model and competitive landscape of the prime brokerage industry.

In this paper, we examine the prime brokerage industry and the challenges it will have to overcome in response to changes caused by the financial crisis.

The prime brokerage industry, a business based on a set of services provided by investment banks and securities firms to hedge funds and professional investors, was largely self-funded and revenue was mainly derived from spreads on financing and lending. While the risk—primarily counterparty risk—was well known, the sheer size of the players made the idea of a prime broker failure seem like a ‘remote’ possibility.

As the prospect of bankruptcy became a harsh reality for prime brokers and their clients, the business model of the prime brokerage industry has been challenged in all of its core aspects; from revenue generation, to risk management, to its operating model. This paper examines the significant consequences on the business model and how this created a complete reconfiguration of the market, challenging the historic duopoly and creating opportunities for newcomers and challengers.

Finally, this paper reviews the prospects in the new, three tier competitive landscape that emerged from these changes: going forward, what are the challenges each tier will face in order to succeed? From the Top Tier – whether historic, dominant or challenger, to the Mini Primes/Boutique Primes, what does the future hold for them?