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Industry Spotlight > Clearing and Custodial Firms

Clear Thinking

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Huge changes are in the wings for how the financial services industry does business, and no area is on heightened alert more than the clearing space.
“Regulation is the big, burning issue — what’s it all going to look like?” says Robb Combs, director of correspondent clearing at Raymond James & Associates, in St. Petersburg, Fla.

But smart clearing firms aren’t simply sitting on their hands waiting for the new rules to be shaped and documented. They’re lobbying in Washington on behalf of clients, developing systems and services in anticipation of the new requirements and broadening their scope of initiatives to support clients once the new regs are in place — months, or even years, from now.

The background is one of fierce competition for clients, with clearers lumbered by decreased revenue because of historically low interest rates, shaky transaction volume and the loss of accounts stemming from brokerage mergers that occurred with the global financial meltdown.

“On all levels, it’s very, very competitive. [Some firms] are much more aggressive both in the pricing they’re willing to offer [companies to move] and incentives — up-front money, like ‘signing bonuses’ — to win a piece of business,” says Sean Malloy, senior vice president and director of global sales and marketing, Penson Financial Services, in New York City, with about 400 U.S. clients.

Getting Political

Emerging from all this upheaval is a new version of the clearing firm. It is a business model that has morphed from the old-school clearer of bygone years to one that operates on a far broader scale. And now, even bigger changes are afoot.

“The business is evolving away from [just] being a processor. Today [broker-dealers] are looking not only for a processing leader but a thought leader because their dependency on their clearing firm goes well beyond the notion of processing,” says William Coppel, chief client growth officer of Wells Fargo Advisors’ First Clearing, based in St. Louis. The firm has 100-plus clients.

Thought leadership among clearing firms is showing up in a number of ways. Right now, probably the most important one addresses the regulatory overhaul and its forthcoming industry-wide challenges.

One example of thought leadership is major clearing companies’ significant presence on Capitol Hill. Their purpose is to reflect client views vis-à-vis the new regulations. “There are many groups spending a lot of time and money lobbying to make the change more in the direction that works best for them,” says Craig Gordon, director of correspondent and advisor services, RBC Correspondent Services, in Minneapolis, serving more than 200 firms.  Since RBC U.S. Wealth Management CEO John Taft is chair of the Securities Industry and Financial Markets Association (SIFMA), Gordon is tracking the proceedings quite carefully.

Fidelity Investments’ National Financial “channels the thoughts” of its more than 300 clients “to the folks in Washington to provide thought leadership to the regulatory bodies — opinions on how the rules should be written for maximum impact,” says Sanjiv Mirchandani, president, based in Boston. “Then we provide insights to clients on how to deal with the rules. The [regs] need to accomplish what they intend to but not create too much burden to the point where it’s unproductive.”

Pershing, an affiliate of BNY Mellon and with 1,150-plus clients, the No. 1 clearer, holds ongoing regulatory conversations with the SEC, SIFMA and FINRA.  “We take responsibility to act as a mouthpiece to reflect clients’ views as the rules and regulations are being shaped. There’s still a lot of wood to chop to clearly define what they’re going to be,” says Michael Row, managing director, from the firm’s Jersey City headquarters.

Building Skills

Thought leadership is apparent too in some firms’ efforts to help ensure that FAs are properly skilled to meet the complex needs of today’s and tomorrow’s investors.

For instance, First Clearing’s Growth Accelerator Program pairs B-Ds’ financial advisors with actual coaches to give them a boost to the next level of performance. “They act as the advisor’s conscience and hold them accountable to reach the goals [the FA] has set,” Coppel says.

Not since the 1930s and 1940s has the financial services industry undergone such major change, says RBC’s Gordon. “We’ve been spending a lot of time looking at what this means to advice-giving practitioners. It’s a game-changer: clearing firms are going to have to be very responsive to the new ways the industry will be working. Creative, successful broker-dealers and advisors will need new tools and resources in this new world.”

At the core of the regulatory revamp is investor protection. “[The government] is attacking it from all angles,” Gordon observes. “It’s disclosure, the fiduciary standard, the safe-keeping of assets. For the clearing industry, this is an opportunity, to a certain extent.”

As for protecting the broker-dealers and advisors, Atul Kamra, president of First Clearing, notes: “To protect yourself effectively, you need to have the right diligence, the right documentation — and the right mindset. The umbrella issue is that there’s going to be much more transparency and diligence in connecting clients to the right solutions.”

Indeed, First Clearing is focusing much of its energy on helping clients protect their businesses. Says Coppel: “The notion of risk management will manifest in systems we develop particularly as they relate to transparency, disclosure and documentation issues.”

One new First Clearing product is a contact management system fully integrated with its back-office system. This should be especially helpful in “capturing everything that transpires between advisor and client, including details on why [specific] investment recommendations are made and whether or not the client accepted them,” Coppel says.

First Clearing is also building its next generation of monitoring and surveillance tools so that advisors, clients and branch managers, according to Kamra, “are in a position to make sure the solutions they’re serving up match clients’ needs and risk profiles.”

Raymond James’ “X-ray” software produces information, included on investors’ statements, that reveals specific holdings within variable annuities, as well as the managers’ performance. Raymond James clears for 38 clients.

To be ready for the new business model, clearing firms — the backbone of the industry — must, most of all, be flexible. That means developing new capabilities. The best prepared firms will be able to support multiple platforms. Some clearers have recently strengthened their fee-based offering and are also catering to so-called hybrid advisors, whose compensation is derived from both transactions and fees.

Pershing is rolling out an enhanced managed-account platform with block trading and rebalancing. National Financial has an augmented broker workstation with, among other features, on-demand reporting combined with alerts. And RBC is working on amplified financial, performance and client reporting to assist firms in meeting disclosure requirements whether their advisors are transaction-based, fee-based or paid according to other arrangements.

“We’ve centered our focus to support the clearing business of the future around the flexibility that practitioners need to work in this new world,” Gordon says.

The biggest regulatory change en route is that — based on the SEC’s recommendation last January — all FAs and brokers are expected to be held to a fiduciary standard, not merely the traditional suitability standard.

“Industry groups and regulatory organizations are grappling with that — how it will all come out. But we know there’ll be more disclosure responsibilities, and everyone feels [doing business] will be absolutely different,” says Gordon.

Boutique firms created by break-away wirehouse brokers will be quickest to adapt to the new model, Gordon opines. “They’re more nimble and looking for change. That [idea] translates right to the clearing firms. Those not as invested in the old way of doing business may be in the best position to respond to the new industry model that’s being created as we speak.”

Profit Pressures

Meantime, clearing firms are in the clutch of profitability issues. They have lost revenue — and continue to do so — owing to the past three years of extremely low interest rates. It is interest revenue — associated with margin, cash and money market account balances — that makes clearing “a lucrative business,” Gordon says.

Comments National Financial’s Mirchandani: “Until we have a rise in interest rates, I don’t see the brokerage or clearing business returning to their full level of profitability. That continues to be a drag on the business.”

But Pershing’s Row says that clearing firms’ loss of interest revenue “obviously hasn’t had catastrophic impact, and I certainly don’t believe it makes or breaks any of the firms. While low rates have injured the revenue picture for us and others, having a multi-faceted revenue base, as we do — not being completely reliant on any one component of the revenue pie — serves us well.”

Such isn’t the case with Penson Financial Services, a pure-play clearer and part of public company Penson Worldwide, whose stock is trading at concerning levels.

Malloy acknowledges feeling “pressure to perform. We don’t have another line of business. We’re entirely reliant on clearing.” But, he says, “at the end of the day, I’m very glad because we’re not competing with our customers in any way,” like owning a broker-dealer.
Loss of interest revenue is partly the reason clearing firms are pitching more aggressive pricing and providing “upfront checks” to win business, says

Malloy. “In the past, you’d see that for only some of the large opportunities, and rarely. This year you’re seeing it even for smaller start-up companies.”
Still, Gordon contends that if, over the next two years, interest rates remain at low levels, clearing prices will go up. “It should be happening today; but, competitively, nobody is ready to take that first step. It’s always been a price-competitive market with prices going down, but we’re probably going to see that turn because that [interest] revenue source isn’t there anymore.”

Yet, in their new role as thought leaders, clearing companies are looking at the industry long-term.

For instance, National Financial is helping clients think through the practical need to bring new advisors into the business to serve Generation Y — whose eldest members are age 33 — now entering its wealth-producing years. The average advisor is 50; a significant number of FAs are over 60 years of age, Mirchandani says.

“Many [younger] investors are going to self-directed models and doing a lot of online investing,” he says. “If the brokerage business doesn’t find a way to serve them with advice, it will lose them. They do it differently, and that means finding new ways to bring in new advisors. This ultimately will ensure the long-term viability of the business.”

First Clearing has created a training program to help clients recruit individuals to become brand-new advisors.    “Attracting new blood to the industry is another huge challenge for the business today,” Coppel notes.

Tangentially, Pershing is providing broker-dealers with technology particularly attractive to younger-generation advisors: its NetX 360 advisor platform/workstation is now available on the iPad.

Apart from stressing technological innovation, Pershing is placing more emphasis on “consultative value. This goes beyond the definition of a clearing firm’s basic blocking and tackling,” Row notes. “It’s two-way client communication: we’re giving ideas; we’re getting ideas.”
He adds: “Today ‘clearing,’ in and of itself, is too narrow a definition.” Rather, “we’re in the financial services outsourcing business.”


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