Omnibus accounts

Omnibus accounts allow financial intermediaries to combine multiple clients' assets into a single, consolidated account. This creates one large account that holds assets for many different hedge funds simultaneously. While all the assets sit together in this single account, the intermediary—such as a fund administrator or prime broker—keeps detailed, separate records for each individual client.

This setup creates efficiency for the intermediary while still tracking exactly which assets belong to which client. Each hedge fund's positions and transactions remain properly allocated and documented, even though the actual assets are pooled together at the account level.

Prime brokers organize their client relationships using two main types of accounts, each serving different purposes. First, they maintain custody accounts, which hold assets that remain under the fund manager's direct control. The prime broker cannot use these assets for its own business activities or pledge them as collateral for other deals.

Second, prime brokers operate margin accountsTrading accounts where investors borrow money from brokers to purchase securities, using the securities as collateral for the loan., which contain assets that hedge funds have pledged to secure their obligations. These pledged assets help cover requirements like trade settlements or financing arrangements with the prime broker. The key difference lies in control: custody account assets stay protected, while margin account assets can be used by the prime broker as collateral.

Prime brokers help hedge funds simplify their complex trading operations across multiple markets. Without a prime broker, a hedge fund would need to maintain separate relationships and asset accounts with dozens of different executing brokers and trading venues. This creates enormous operational complexity.

Instead, hedge funds can centralize their clearing and settlement through a single prime broker while still accessing diverse execution venues for their trades. The prime broker acts as a coordinator, working with various executing brokers to handle trade settlement and asset movement. This arrangement allows fund managers to focus on finding the best execution for their trades rather than managing numerous operational relationships.

The benefits become particularly clear for funds that trade frequently across different markets and asset classes, where managing multiple broker relationships would otherwise consume significant time and resources.

The 2008 financial crisis fundamentally changed how hedge funds think about prime broker relationships. When Bear Stearns and Lehman Brothers collapsed, some hedge fund managers discovered they could not withdraw their collateral from these troubled investment banks. These managers had provided securities and cash as collateral for margin financing, but when the prime brokers failed, accessing those assets became extremely difficult.

This experience taught the industry important lessons about counterparty riskThe risk that the other party in a financial transaction will fail to meet their obligations, potentially causing financial loss.. Many hedge fund managers now require their prime brokers to move all non-collateral assets into a separate custody account at the end of each trading day. A third-party custodian holds these assets and cannot lend them or use them as collateral for other transactions.

While this triparty arrangementA custody arrangement involving three parties—the fund manager, the prime broker, and an independent custodian—where non-collateral assets are moved to a third-party custodian at the end of each trading day to protect them from prime broker insolvency risk. creates additional fees and administrative work, it protects fully paid assets from prime broker insolvency risk. The trade-off reflects how the industry now prioritizes asset protection over operational convenience.

Government regulations require prime brokers to keep client securities separate from their own company assets. This segregation creates important protective barriers. Investment advisers registered under the federal Investment Advisers Act Investment Advisers Act of 1940 The Investment Advisers Act of 1940 is the primary U.S. legislation regulating investment advisers, including hedge fund managers, establishing registration requirements, fiduciary duties, disclosure obligations, and compliance standards for advisers meeting certain thresholds. must follow Rule 206(4)-2 SEC Rule 206(4)-2 Rule 206(4)-2 (the Custody Rule) under the Investment Advisers Act imposes requirements on registered investment advisers with custody of client assets, including hedge fund managers, mandating use of qualified custodians, account statements, and surprise examinations. , which requires them to use qualified independent custodians for client funds and securities.

These regulatory structures help protect hedge fund assets from problems that might arise with the service provider's business. If a prime broker faces financial difficulties, properly segregated client assets should remain protected. Recent regulatory changes have strengthened these protections—large broker-dealersA person or firm engaged in the business of buying and selling securities for the account of others or for its own account. with over $500 million in customer credits must now perform daily monitoring of customer protection requirements, compared to the previous weekly schedule. This increased frequency helps regulators spot potential problems more quickly.

U.S. securities laws place strict limits on what broker-dealers can do with customer assets. Rule 15c3-3Securities Exchange Act rule requiring broker-dealers to segregate customer assets and maintain reserve accounts to protect client funds, also known as the customer protection rule. of the Securities Exchange Act Securities Exchange Act of 1934 The Securities Exchange Act of 1934 is the primary U.S. legislation governing securities trading, establishing the SEC and imposing various reporting requirements on public companies and institutional investors, including certain hedge fund managers and activities. governs these activities and provides important customer protections.

Fully paid securitiesSecurities that have been paid for in full by the customer and cannot be rehypothecated by broker-dealers under US regulations.—assets that customers own outright without any margin debt—cannot be rehypothecated Rehypothecation Rehypothecation refers to the practice where prime brokers use hedge fund assets posted as collateral to secure their own borrowing or trading activities, a practice often limited in prime brokerage agreements to reduce counterparty risk. (re-pledged) by U.S. broker-dealers. Additionally, if a customer's pledged margin securities exceed 140% of their debt balance with the broker, the broker must treat these "excess margin securitiesThe portion of margin securities exceeding 140% of a customer's debt that must be segregated and protected from rehypothecation." the same way as fully paid assets. This prevents brokers from over-pledging customer assets.

However, these Exchange Act limitations only apply to prime brokers that are registered as U.S. broker-dealers. Prime brokers operating under other regulatory structures may not face the same restrictions, which creates important considerations for hedge funds when selecting their prime brokerage relationships.