It’s no secret that the global financial collapse has pushed vitally important risk management front and center.
And perhaps no other segment of the financial services industry is more focused on certain aspects of this issue than clearing firms.
There are, of course, several types of risk to manage: market risk, credit risk, management risk and so on. It is reputational risk to which clearers are giving their unremitting attention.
“It’s a new world. Anyone who believes that the policies and procedures as written two or three years ago about who they do business with remain adequate needs to examine them. Because of the things that have happened, they require a new level of scrutiny by everyone,” says Jim Crowley, managing director of Pershing, an affiliate of Bank of New York Mellon and, with 1,150 clients, the largest clearing firm.
Clearing has always been a risk business. But since the financial crisis, companies are indeed more intensely evaluating and reevaluating the clients that come through their doors.
“What’s changed is that there’s an increasingly continuous and evolving look at risk,” says Dan Weingarten, vice president and head of global sales and marketing for Penson Worldwide, based in New York City. “We need to make sure that firms match up with the profiles we expected and that their business continues to matchup. If it changes, we’ll go back and ask them for higher clearing deposits or increase rates for the new lines of business.”
At Raymond James & Associates, with 38 clients, specialists have been brought in to focus on counterparty risk relating to all the firm’s outside partners.
“Counterparty risk is the buzzword. Everybody is trying to get more transparency into service-provider relationships and understand their clients better in order to mitigate any potential challenges in the future,” says Robb Combs, director of correspondent clearing, in St. Petersburg, Fla.
“It’s more scrutiny and further due diligence. Probably someone could have done more of that on their relationship with Bernie Madoff,” Combs adds, stressing the necessity of this investigative work.
Sifting out the good broker-dealers from the less-than-desirable has been common practice for clearing firms in establishing new relationships. But today, when even the strongest have failed, it is paramount.
Clearers are being super-careful. “We sometimes find ourselves turning down more firms than we take,” says Craig Gordon, director of correspondent and advisor clearing at RBC Correspondent Services, in Minneapolis, which clears for 170 clients. “That’s not because we think they’re bad people or the firms are doing bad things but that their risk profile doesn’t fit our comfort level.”
Broker-dealers selling derivative securities, in particular, are getting a thorough going-over in view of the damage that’s resulted from their improper sale. Clearers say they must be ever-vigilant about the firms with which they align themselves. For example, First Clearing, a non-bank affiliate of Wells Fargo, with 114 clients, virtually steers clear of BDs using derivatives.
“Over the years, the industry was lulled into a sense of complacency and almost on a robotic basis, processed these products without, perhaps, understanding them at the level they needed to and without preparing themselves to manage the risk associated with them should something occur,” says William Coppel, First Clearing’s chief client growth officer, based in St. Louis.
“It will be challenging for those clearing firms who are playing in the [derivative] space to make sure they’re really scrutinizing the business,” Coppel notes.
On the Upside
Now on to the good news in clearing: firms serving mostly small- to mid-sized BDs have actually benefited from last year’s calamitous upheaval. Wirehouse and bank acquisitions have brought a huge, steady advisor migration out of these institutions and into the independent world. What a boon for clearers, who are helping to recruit.
This shift, says Gordon, “will give a big boost not only to broker-dealers but to the clearing industry. In fact, it wouldn’t surprise me if [eventually] two-thirds of the business will go through independent firms that clear through others and one-third goes through wirehouses — instead of the other way around,” as now.
“We’ve seen a lot of our middle- and smaller-tiered correspondents expanding because they’ve been able to go after the ‘unattainable broker,’” says Weingarten, of Penson, with 300-plus clients. “Historically, it was very hard for a smaller firm to pursue a wirehouse broker with a big book of business because he was established and had a good payout — and wasn’t necessarily looking to leave.”
To be sure, the BD expansion has given a substantial lift to clearing firms, who are helping to build brokerages’ rapidly growing advisor base.
Recruiting big producers out of major firms, some BDs are even doubling their business, Gordon says. “It’s exciting! We’re seeing the traditional wirehouse financial consultant going independent or setting up their own business faster than anybody ever imagined six months ago, when this was predicted.”
He adds: “The stability and strength of some [wirehouses] vanished — in certain cases overnight. It made very successful financial advisors reevaluate what they needed in order to service their clients. And it gave them an out [to leave their firms] and say, ‘Things have changed. I need to have the resources to meet your needs. I can do that at an independent firm with a strong clearing partner.’”
National Financial, a Fidelity Investments company, with 310 clients, is helping clients recruit wirehouse advisors to “soft-transition them to being on their own and to help with the conversion process,” says Mark Healy, executive vice president for client management.
As a result of last year’s M&As, National Financial, according to its competitors, lost some big accounts — most prominently, Bank of America and JP Morgan Chase — which now have their own clearing entities.