Prime Brokerage Under Fire: Why Regulators Are Fighting the Last War
Regulation has always been a game of looking backward. The cycle is predictable: a crisis occurs, risk is misdiagnosed, new rules are imposed to prevent a repeat of the past, and in doing so, capital is pushed into places where regulators can’t see it—until, inevitably, it resurfaces in ways they never anticipated.
Rebecca Jackson’s recent speech at UK Finance follows that same familiar pattern. As Executive Director at the PRA, she oversees the world’s largest prime brokers. Her message was careful, measured—more of a warning than an outright attack. But the subtext was clear: prime brokerage is growing too fast, leverage is being obscured by netting, hedge funds are not transparent enough, and liquidity risks are underestimated. The implication is unmistakable. This is the beginning of a regulatory tightening cycle.
The problem is that much of this framing is flawed. Jackson’s concerns reflect an outdated regulatory worldview—one that hasn’t caught up with how modern liquidity works, how risk is priced, or how capital formation actually happens today. It is an analysis rooted in the past, fighting problems that no longer exist while ignoring the new ones that do.
Prime Brokerage Growth: A Feature, Not a Bug
Jackson begins by pointing to the rapid growth of prime brokerage balances. Equity markets have surged, hedge fund assets have swelled, and as a result, financing demand has increased. She correctly identifies the rise of quantitative strategies—market-neutral, high-turnover, leverage-intensive funds—as a key driver of this expansion. She also acknowledges the broader shift in capital allocation, as investors move away from traditional fixed income into hedge funds, private equity, and private credit.
But where she sees warning signs, the market sees something else entirely. Growth in prime brokerage is not a sign of unchecked risk-taking; it is a reflection of the structural evolution of market liquidity provision. This is a business that has scaled because scale is what makes it more resilient.
Larger prime brokers internalize trades, reducing reliance on external liquidity. They match long and short positions across their clients, creating efficiencies that shrink system-wide leverage rather than expanding it. They optimize balance sheet usage, allowing capital to be deployed more effectively across market cycles. This is not risk accumulation—it is risk dispersion.
Regulators have a tendency to assume that growth is synonymous with fragility, but in this case, the opposite is true. Scale is not the problem. Scale is what prevents market dysfunction.
Gross Exposure Is a Red Herring
Jackson also takes issue with the way prime brokers assess risk. She argues that reliance on netted risk measures—potential future exposure, collateral frameworks, stress testing—can obscure true leverage levels. Instead, she suggests, regulators should focus more on gross exposure.
This is regulatory misdiagnosis at its finest. Gross exposure, in isolation, is a meaningless figure. It tells you nothing about risk concentration, market impact, or funding stability. A hedge fund with $50 billion in long positions and $49 billion in shorts is not systemically equivalent to a fund that is levered long $50 billion. But under a crude gross exposure framework, they might be treated the same.
This is precisely why risk is managed through structure, not size. Modern prime brokerage already incorporates real-time portfolio hedging, cross-product offsets, and dynamic collateral adjustments. It is why financing terms vary so widely across hedge funds—because leverage alone is not what matters. The composition of that leverage, its funding stability, and the liquidity profile of the underlying positions are what determine real risk.
If gross exposure were a useful measure of systemic fragility, regulators would have caught Archegos before it collapsed. But they didn’t—because gross exposure alone provides no insight into whether a portfolio is stable or vulnerable, liquid or trapped, hedged or reckless.
The Flawed Push for More Hedge Fund Disclosures
One of the core regulatory instincts is to demand more transparency, and Jackson’s speech follows that playbook. She argues that prime brokers should be stricter in requiring hedge funds to disclose more about their risk exposures, leverage levels, and liquidity positioning. It is the kind of argument that sounds reasonable in theory but falls apart in practice.
Forcing greater transparency does not necessarily reduce risk. In many cases, it creates new ones. If hedge funds are required to disclose sensitive portfolio details, they will alter their behavior. They will reduce leverage, but they will also reduce liquidity provision. They will change position sizes, not necessarily to reduce risk, but to minimize regulatory scrutiny. They will shift exposures into unregulated financing structures, pushing risk into places where it becomes harder—not easier—to track.
This is the irony of excessive disclosure: it does not prevent fragility; it simply moves it somewhere less visible. Regulators believe that requiring more data will allow them to predict the next crisis. But history suggests otherwise. There was no shortage of disclosure before 2008—regulators simply failed to interpret it correctly.
Prime brokers already price transparency into financing terms. Hedge funds that provide more data get better funding conditions. Those that don’t, pay a premium. This market-driven mechanism works better than any top-down mandate because it naturally aligns incentives without distorting market structure.
Liquidity Risk: The Real Issue Regulators Should Be Focused On
If there is one area where Jackson is correct, it is in recognizing that prime brokerage balances can be flighty in stress scenarios. But here again, the regulatory interpretation is flawed. The real risk isn’t that prime brokers pull financing. The real risk is that regulatory liquidity frameworks create bottlenecks that prevent liquidity from flowing where it is needed most.
The problem starts with Basel’s Liquidity Coverage Ratio (LCR), a metric designed for traditional banking, not capital markets. It forces institutions to hold liquidity buffers against the wrong types of outflows, creating artificial funding constraints in periods of stress.
The real issue is collateral mobility. Market shocks do not become systemic because of margin calls; they become systemic when collateral gets trapped inside regulatory silos, unable to be redeployed efficiently. When risk moves faster than the ability to reallocate capital, that is when funding dislocations become dangerous.
If regulators truly want to improve liquidity resilience, they should be focused on ensuring that collateral transformation remains fluid in stress environments, rather than layering on new prime brokerage restrictions that could inadvertently make market disruptions worse.
Fighting the Last War
Regulatory oversight is necessary. No one disputes that. But bad regulation—the kind based on outdated models and misplaced assumptions—creates more risk, not less.
Jackson’s speech reflects the classic regulatory impulse:
Assume that growth means excess.
Treat net risk management as deceptive.
Demand more transparency, without considering the consequences.
These are misguided instincts that fail to account for how modern financial markets function. The real danger is not that prime brokerage is growing too fast. The real danger is that regulators are still working off risk models designed for a world that no longer exists.
If they get prime brokerage oversight wrong, liquidity won’t disappear. It will migrate into unregulated spaces, where risk concentration will intensify until the next crisis erupts somewhere no one was looking.
That is the real lesson of financial history. Risk doesn’t vanish. It moves. And it moves fastest when regulation forces it into the shadows.
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