How Does Collateral Management by a Prime Broker Mitigate Credit Risk?
Collateral management involves the prime broker receiving and holding assets (collateral) from the client to cover the client's potential obligations in derivatives trades. By valuing the collateral daily and requiring top-ups (margin calls) when its value falls, the prime broker ensures it is protected against the client's default.
This secured position drastically reduces the credit risk assumed by the prime broker.
Glossar
Broker
Delegation ⎊ In the context of decentralized finance, the function of a broker is often delegated to smart contracts or non-custodial execution layers, removing direct counterparty risk.
Credit Risk
Exposure ⎊ The potential for financial loss due to the failure of a borrower or counterparty to fulfill their debt obligations, a key consideration when underwriting decentralized loans or providing liquidity to lending pools.
Prime Broker
Facilitation ⎊ A prime broker, within cryptocurrency derivatives and options trading, functions as an intermediary providing services to hedge funds and other large institutional investors.