Funding Pressures Are Back: What it Means for Hedge Funds and the Prime Brokerage Landscape
After years of low-cost leverage, equity financing costs are back in the spotlight—and not in a good way for most market participants. Borrowing costs to short equities have jumped, and stock loan rates are materially higher than they were even a year ago. Many prime brokers are increasingly steering clients toward equity swaps as an alternative, which introduces its own pricing complexities. Whether funds are using margin, swaps, or borrowing stock directly, the reality is the same: financing has gotten more expensive.
This matters, especially for small and mid-sized hedge funds and family offices. Higher funding costs eat directly into returns, making previously profitable strategies less compelling. For long/short equity funds in particular, this environment demands a re-evaluation of financing arrangements and a closer look at prime brokerage relationships.
A New Cost of Doing Business
Financing costs are the invisible tax on leverage. When hedge funds short equities or trade through swaps, they’re effectively renting balance sheet from their prime broker. That rental cost—a combination of the risk-free rate, a borrow fee, and an added spread—has climbed significantly.
In theory, higher spreads should normalize as markets stabilize. But this time, that isn’t happening. Even after recent volatility brought equities lower, funding costs have stayed stubbornly high. Research from JPMorgan shows that financing costs remain in the top quintile of the past five years.
The persistence of these elevated levels suggests structural, not cyclical, forces are at play.
Demand Is High. Supply Is Constrained.
The first piece of the puzzle is demand. A wave of systematic and derivatives-based strategies has increased the need for leverage and stock borrow. Long/short equity funds, quant strategies, and macro portfolios are all competing for a limited pool of prime brokerage capacity.
But the real story is on the supply side. Major banks—still the dominant providers of equity financing—are constrained. Post-crisis regulations, particularly Basel III and the Supplementary Leverage Ratio (SLR), have forced banks to ration their balance sheets.
This matters because when a bank extends leverage or lends hard-to-borrow stock, it has to reserve capital against that exposure. As bank balance sheets fill up, equity financing becomes a more scarce and expensive commodity.
In today’s environment, that scarcity is showing. Traditional prime brokers are less willing or able to provide balance sheet at scale—and when they do, it comes at a premium. Many banks are also pushing clients toward equity swaps, which allow them to manage balance sheet exposure more efficiently—but often with less transparency and less favorable economics for the client.
Why It Hurts Smaller Funds More
The current dynamic disproportionately impacts small and mid-sized hedge funds. Large multi-manager platforms and the biggest global macro funds still command balance sheet access, albeit at higher prices. But smaller funds—those running a few hundred million or less—are often left with take-it-or-leave-it pricing, inflexible margin terms, or reduced access altogether.
This trend isn’t new, but it’s becoming more pronounced. Several of the bulge-bracket banks have made clear they are focusing prime brokerage resources on their largest clients. That leaves emerging managers and family offices caught in the middle: needing leverage to stay competitive, but increasingly priced out of efficient access to it.
The result? Reduced capital efficiency, narrower strategy spreads, and more time spent managing financing logistics instead of generating alpha.
A Market Opportunity, If You Have the Capital
There is a flip side to this imbalance. For cash-rich entities or firms with large, unconstrained balance sheets, these dislocations are attractive. Higher stock borrow costs and wider swap spreads open up arbitrage opportunities—such as facilitating short positions for others or entering into synthetic financing trades.
Pension funds, sovereign wealth funds, and large asset managers are stepping in to provide financing directly or indirectly, capturing the elevated spread that banks can’t efficiently intermediate.
Some hedge funds have adapted by deploying their own balance sheet where possible, or by reducing reliance on traditional PB services. Others are looking beyond the bulge bracket for better terms.
The Prime Brokerage Model Is Shifting
This environment is reshaping the prime brokerage industry. The historical dominance of a few global banks is being challenged not just by cost, but by structural constraints. In their place, asset managers, non-bank dealers, and boutique primes are expanding their role.
Crucially, the ability to commit balance sheet has become the differentiator. Execution services and technology matter, but in a world where stock borrow and swap financing can vary by 50 to 100 basis points depending on your provider, balance sheet is king.
Hedge funds that proactively revisit their financing relationships are finding opportunities to reduce drag, improve flexibility, and secure more durable terms. That might mean diversifying across providers, engaging with newer entrants, or negotiating more bespoke terms.
Looking Ahead
It’s unclear whether elevated funding costs are the new normal or just a temporary dislocation. But either way, hedge funds and family offices can’t afford to ignore the shift.
In a high-rate, balance-sheet-constrained world, prime brokerage is no longer a commoditized service. Major banks are selectively allocating their balance sheet to the largest and most profitable clients, often leaving smaller funds with limited access, higher costs, or less favorable terms. It’s a strategic input. Managers that treat it as such—and partner with providers who have both the willingness and ability to extend balance sheet—will be better positioned to compete.
For funds navigating this environment, the message is clear: financing is no longer a back-office detail. It’s a front-office priority.