From the September 2012 issue of Research Magazine • Subscribe!

Clearing's New Space

For clearing firms, innovation and scale are the keys to success—and survival.

In these challenging times—lethargic economy, record-low interest rates, high market volatility, softer trading volumes and a regulatory overhaul—the top firm in the clearing space has decided to totally transform its business model.

Pershing, an affiliate of BNY Mellon, is indeed making profound structural changes to deal with the issues facing financial services.

In so doing, it is broadening its custodial responsibilities and placing more focus on assisting its 1,500 clients to grow. Within that imperative, it is helping advisors transform their practices through increased operating efficiencies and methods to expand client assets.

“The way that broker-dealers and RIAs operated two or three years ago won’t be sustainable to get through this environment and come out the other end,” says Jim Crowley, a Pershing managing director, based in Jersey City, N.J. As part of the transformation, Crowley was recently assigned the additional post of chief relationship officer, encompassing the full breadth of Pershing’s customer base. He continues to be responsible for global customer U.S. business, though day-to-day responsibility is now under another managing director, Michael Row.

Clearing firms are middlemen in more ways than the usual sense: On one side, they are pressed by the onslaught of tighter industry regulation; on the other, the urgent needs of clients to differentiate themselves, compete and grow. Increasingly, BDs are looking to these intermediary firms for help and guidance.

 That is a huge attitudinal change.

“In the old days, broker-dealers said, ‘You’re a vendor—stay out of my business. We’re not interested in your point of view.’ Today, it’s the complete opposite—a 180-degree turn. It’s ‘Come on in, sit down, help us understand how we can do things better and more effectively to get more return on the assets we have and help us manage risk’,” says William Coppel, chief growth officer of First Clearing, in St. Louis, which has 90 clients.

 At RBC Correspondent and Advisor Services in Minneapolis, Craig Gordon, director, sees the clearing firm’s pivotal role as “the heart of the financial services industry. It holds the assets: Everything connects to it. And, like the body’s heart, the clearing firm’s [job] is to make sure everything flows through smoothly and to support financial advisors so they can run fast and have stamina.”

Indeed, the big challenge for the heart continues to be low interest rates. “You just don’t have that revenue that was there previously,” Gordon notes.

This situation is one reason Pershing stresses “the necessity” for business-model transformation. “You just can’t wait for interest rates to come back up. That can’t be your strategy,” he says.

BDs are suffering just as much as the clearers when it comes to low interest rates.

Like Crowley, Sanjiv Mirchandani, president of National Financial, emphasizes: “This is a time when strategy is important. And so firms are reassessing their strategies.” A unit of Fidelity Investments, National, with nearly 300 clients, is the No. 2 clearer.

“There’s no way [for clearing firms] to completely offset the revenue that’s being lost because of low interest rates,” Mirchandani adds. “You don’t want to take on too much risk to attempt to offset it all. But we’re focused on helping our clients grow their recurring revenues, reduce expenses and improve efficiency.”

The firm is assisting BDs to grow their fee-based business with, for instance, managed accounts. “As [FAs] move to a fee-based model,” Mirchandani notes, “these accounts become recurring revenue sources.”

 Growing Menu

Pershing has given BDs a boost to increase their fee income by providing mutual fund programs that allow them to process trades at no cost. That was made possible through the firm’s collaboration with BNY Mellon’s Capital Markets broker-dealer subsidiary.

Further, in April of this year, Pershing aligned its fixed income trading desk with Capital Markets, a move that allows it to underwrite fixed income products.

“This lets our broker-dealers receive fee income they previously didn’t get,” Crowley notes. “We’re trying to help them find new sources of income because as a result of higher interest rates, revenue sharing is not going to be the solution.”

The government’s sweeping regulatory reform, though proceeding slowly, weighs heavily on clearing firms.

 “The bar is going higher. There is no question that it will continue to go up—and the expense related to dealing with it is real,” Crowley says. “This will continue to put pressure on the operating margins of not only clearing firms but also introducing broker-dealers because additional capital will be required to address the new regulatory changes that are coming through.”

This is another major reason for the recurrence of a trend toward self-clearing firms moving to a fully disclosed model, thus outsourcing through clearers.

“We’ve seen renewed interest from self-clearing firms,” says Mirchandani. “We’re very focused on the outsourcing trend because there are real opportunities for us to pick up market share.”

Meantime, the clearing firm count continues to dwindle.

Last May, Penson Worldwide exited the business in the United States. A new company, Apex Clearing Corp., is acquiring Penson’s approximately 230 U.S.-based correspondents.

“We believe this transaction represents the best solution for our U.S. securities correspondents [and] their customers,” said Bryce Engel, Penson president, in a statement.

The Penson Financial Services division concentrated on basic clearing functions of processing and execution.

Its leaving the business reflects, in part, a salient issue in the clearing space. “If you’re in the traditional clearing business of processing,” Coppel says, “you’re going to feel tremendous pressure because today that’s a commodity.”

He continues. “It’s almost at the point where processing is ancillary to our core competency. Everyone has to be able to process. But your core competencies need to revolve around how you can help firms create a competitive position in the market. If you’re not doing that, you’re likely to feel pressure.”

This is why leading clearing firms are devoting so much energy to helping clients grow share in today’s fiercely competitive marketplace.

Last July, 50 advisors gathered in midtown Manhattan for an all-day workshop on practice management for successful FAs. It wasn’t a BD that hosted the New York City session; it was presented by RBC Correspondent and Advisor Services, one of a dozen free client workshops the clearer conducts around the country.

The initiative plays to the steady stream of advisors—a great many of them, big producers—who are breaking away from wirehouses to go on their own.

“We’re supporting them with all the resources financial advisors need to conduct their business at an independent firm,” Gordon says. “While they don’t want to be part of the wirehouse anymore, they want all the capabilities they had at the wirehouse. There’s a whole industry continuing to advance in supporting advisors who are leaving large-scale firms and setting up shop within small boutique practices.”

That trend is indeed positive for the clearing industry because “it creates a lot of opportunities for the brokerage firms we clear for,” Gordon points out.

There is no doubt that BDs are eager to leverage their clearing firms’ value-added services. Huge among these is cutting-edge technology. National Financial, for example, is making a big push to move BDs to a paperless office with its Workflow Management System, among other efficiencies. It is also satisfying client needs with an array of mobile solutions for the iPad and iPhone, as well as Android and other systems. National will shortly roll out a full complement of mobile devices. And it recently introduced a how-to tool to help advisors get more referrals from their client base by tapping into centers of influence.

Earlier this year, Pershing launched a new retirement planning tool for the iPad. Called “Retirement Essentials,” it allows FAs to prepare information needed to analyze a client’s IRA or employer’s retirement plan account.

First Clearing was on target to pilot two new tools this August. One is designed to give advisors clearer visibility into their client base; the other helps them craft a plan to address the service models needed to grow those relationships. A late-fall rollout is scheduled.

Pershing’s transformation includes a total redesign of its investor portal, plus providing a 529 college savings plan platform on which BDs and RIAs can process such business directly. “It simplifies everything, is more efficient and lets the BD have greater purview over the assets,” Crowley says.

Another big issue for clearing firms—and surely the industry generally: In the face of prolonged high volatility, many cautious clients are simply not participating in the market.

“Investors are a little skittish,” says Mirchandani. “They’ve sat out a lot of this bull market that began in 2009. What worries me is that we’ve got to get the individual investors back in the game. [Addressing this] a lot of brokerage firms are spending time on strategies to engage investors—including younger ones—to invest for the future.”

Individual investors are not the only ones concerned about asset safety and fearful of another meltdown. So are BDs.

“Even more so than in the past few years, broker-dealers and investors are [worried] about the financial stability of the clearing firms,” Gordon says. “We’re seeing retail customers being more cautious about the place their account is held. And high-net-worth and institutional customers are even looking at ways to diversify custody so they don’t have all their eggs in one basket.”

Pershing is trying to be the “preferred custodian for all the assets for our broker-dealer clients,” Crowley says. “The notion of having an independent third-party custodian is more important now considering that some self-clearing firms have given [the] industry a pretty bad black eye. They were their own custodians. They did bad things, but they were able to disguise them by manipulating their control process.”

Given the relentlessly large investments clearing firms must make to stay competitive—in technology, particularly—smaller companies are expected to continue to depart the clearing arena.

“It’s a tough business to be in and not for the faint of heart,” Mirchandani says. “It’s tougher and tougher to run a sustainable clearing firm. And in this type of interest environment, it’s harder to earn an adequate return on capital.”

Last March, Mesirow Financial, a diversified Chicago-based financial services firm, called clearing quits when it sold that part of its business to RBC. Having converted 50 Mesirow accounts, the Royal Bank of Canada unit now has clients totaling 170 independent BDs and 75 RIA BDs.

Crowley, however, does not foresee large clearing company acquisitions on the near-horizon. Rather, he anticipates further strategic consolidation, such as his firm’s purchase last year of Penson’s clearing business in Australia. Pershing previously had one person handling clearing in the region. Now it boasts a group of 50 there.

“The acquisition,” Crowley says, “gave us instant scale.”

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