From the January 2004 issue of Investment Advisor • Subscribe!

January 1, 2004

Clear Sailing

The market is up. Competition is down. How's that for a trend?

Industry consolidation is taking its toll on clearing firms--on the number of firms, that is. But if you listen to executives at the surviving firms, consolidation has been good for business. So has specialization.

Craig Gordon, a VP and national director of business development at RBC Dain Correspondent Services in Minneapolis, says his firm has been very busy, particularly in the second half of the year. Consolidation has presented Dain with numerous opportunities, he says, as correspondents evaluate their client options in the wake of change. "A lot of [consolidations] were announced at the beginning of the year--Bank of New York acquiring Pershing; Fidelity, CSC; and First Clearing and Wexford merging, so a lot of these are going into evaluation mode, so to speak."

Broker/dealers, says Gordon, spend six to nine months evaluating the consequences of changing their clearing firm. "It affects their entire business," he points out, "technology, products and services, reputation, everything from start to finish." The change generated by consolidation, he says, has led to discussions between Dain and many B/Ds considering making a change, and busy third and fourth quarters with "10 firms moving over" in the last half of 2003, and a number planning to move early in 2004.

Gordon says that the "table stakes" in the clearing business, meaning custody, clearing, trading, and securities transactions, are of course important, but correspondent B/Ds' decisions about new partners "have less to do with settlement and clearing and more to do with finding a custody match with the business that they're in." Some of the most successful correspondents this year, he says, are planning firms that came to Dain specifically "because of our commitment to training their firm and brokers on how to transition to fee-based business," and Dain's attention to how to increase broker production effectively using proprietary practice management tools and technology.

That's "kind of new," he says. "Ten to 20 years ago, it was just custodian and settlement; five to 10 years ago, it was tech and workstations; and now it's practice management."

What about the firms involved in consolidation? Rich Brueckner, CEO of Jersey City-based Pershing, concurs that consolidation has been good for business. "It's our expectation that there will be fewer firms doing what we do in the future," he says. "Because Pershing is fortunate to have very strong customers, we think we'll continue to be advantaged in the marketplace." The firm has been kept busy over the last year, he says, converting more than 200 Bank of New York relationships to the Pershing platform, as well as building business "the usual way, by prospecting and converting accounts." There has also been the business of Pershing's ownership change from CS First Boston to Bank of New York, which Brueckner said encompassed "a thousand transition tasks to be accomplished, most of which have been done in the last eight months."

Consolidation has helped Pershing, he says, because it has combined strengths of the clearing firm and Bank of New York. Pointing toward the increasing trend toward globalization and nondollar business, he says that BNY has brought expertise in global clearing. Brueckner says that a partnership with Lockwood Financial Group, also acquired by BNY, offers a broadening of managed accounts and an increased focus on the RIA market.

Pershing has added value to the corporate mix, he says, pointing to its "broad and deep technological capabilities that Bank of New York did not have." Among those capabilities are 300 customized Web sites for customers, and 700 people in Chennai, India, "who are an integral part of our technology group and support our technological capabilities."

A spokesman at Stock Clearing Corp. of Philadelphia, a registered clearing agency, points to a fixed cost for trades and a real-time risk management system as factors that differentiate it from the pack. The clearing firm offers an SRO umbrella, said the spokesman, "with extremely good margin rates for those correspondent clearing firms that wish to be professional specialists at the exchange." The company's goal is for its clients to be professional traders, not day traders, who deliver "a professional order flow that brings business to the Philadelphia Stock Exchange."

Norman Malo, president of National Financial, Fidelity's Boston-based clearing business, concurs that regulation is a concern; in fact, he says, National Financial's perceived integrity is a major attraction to potential correspondents. Business has been good: Trading volume was up 30% to 35% in 2003, leading to the firm's best revenue year ever. National Financial has been accommodating clients delivered through the CSC acquisition. About a third of those clients have already been brought over to National Financial's platform, Malo says, with the rest to be transitioned in the first half of 2004. The consolidation isn't over, Malo argues. "In the mid-1990s," he says, "there were 135 firms [doing clearing]. Today there are less than 75. We estimate there will be 50 over the next five years."

Clients have become more demanding, too, wanting "speed and technology and better pricing, as well as stronger support from a product standpoint." The big focus at National Financial, he says, is on technology, adding that 2004 will mark an all-time high for technology investment in the correspondent clearing arena for the company. "The only way to compete is through sheer volume of transactions, and the right technology to do it and give better pricing. Straight-through processing, imaging as a platform, and capability--[we're offering] a new workstation in 2004 that will absolutely take our client base up to a new level."

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