Indeed, the new “market access” rule has already gone into effect, as of last July. It compels broker-dealers providing access to an exchange or alternative trading business to adopt and enforce certain risk-management controls and compliance procedures. Clearing firms furnish B-Ds with such access.
“This rule is so onerous that the industry thought the SEC would delay it. But — surprise! — they didn’t. It requires documentation and delineation of responsibilities between clearing firms and introducing brokers. For the next decade, we’ll be experiencing a very sophisticated, very taxing, very onerous regulatory environment,” says Craig Gordon, director of correspondent and advisor services, RBC Correspondent Services, in Minneapolis, which serves more than 200 broker-dealers and investment advisors.
But can those rules and regulations spell opportunity for the clearing industry?
“Painfully, yes,” says Jim Crowley, managing director, Pershing, an affiliate of BNY Mellon, headquartered in Jersey City. With 1,500 client relationships, it is the largest clearer. “This will be a period of opportunity for firms that have the size and scale to prosper and build their base through a difficult time, but it will be a period of further consolidation for smaller firms.”
Despite their role as Wall Street’s behind-the-scenes workhorses, clearing firms are where major evolutionary changes in financial services — such as the big move to high technology — show up first.
Now, in the new, complex regulatory landscape, broker-dealers are relying on clearers more than ever to help them operate efficiently and cost-effectively. To be sure, following the financial crisis, clearing companies became B-Ds’ trusted advisors. And self-clearing brokerages are recognizing, increasingly, the value of outsourcing their clearing responsibilities.
“The silver lining is that with self-clearing firms so focused on cost-cutting and efficiency — and allocating capital only for core competencies — there’s renewed interest in third-party clearing providers,” says Frank La Salla, Pershing managing director, global securities services and corporate development groups.
“While we can’t sugarcoat our [clearing firms’] challenges in this difficult environment, the other side of the coin is that we can bring economies of scale and a higher degree of productivity to firms that wouldn’t even consider [outsourcing] three or four years ago,” La Salla says.
But clearers, like other businesses, remain lumbered by low interest rates’ negative impact on revenues. This has become even more critical in view of the major investments required to administer the new regs.
“It is not a trivial problem,” says Sanjiv Mirchandani, president of Fidelity Investments’ National Financial, with about 300 correspondents and based in Boston. He notes that interest “is a significant portion of the revenue stream, and it’s generally hard to make up all of it.”
Observes RBC’s Gordon: “Low interest rates are continuing to hit the pocketbooks of broker-dealers and clearing firms alike. It’s still a big factor.”
To offset that drain on profitability, clearers are helping clients grow organically by increasing the amount of assets they manage.
“We’re seeing advisors bring in more assets,” says William Coppel, chief client growth officer at Wells Fargo Advisors’ First Clearing. Based in St. Louis, First clears for 100-plus clients. “Ultimately, that’s reflected — for both us and the advisors — in revenues associated with managing those assets. Where the market has taken away, it has given back in some respects.”
Addressing the low-interest-rate situation, Pershing has focused on “capturing more assets as a result of the shift from transactions to advisory,” Crowley says. For its brokerage platform, the clearer is also targeting assets held with third-party custodians. And it has continued to expand globally.
At National Financial, the firm has seen a record number of clients sign on for consulting services concentrating on streamlining operations and boosting efficiency. NF clients also are tapping into parent company Fidelity’s super-large imaging system, with workflow technology that, in effect, turns operations into “a paperless environment,” Mirchandani says.
Entering Phase Three
Most agree that the ever-changing clearing industry is now in Phase Three of its evolution. The first phase, of course, centered on processing; the second was characterized by the widespread adoption of new technology and value-added services. Phase Three is shaping up to be distinguished by growing differentiation among firms.
“It’s like the medical profession evolving from the general doctor to specialist care,” Gordon says. “Broker-dealers won’t be able to meet their customer or regulatory needs unless they work with a specialist clearing firm that really understands what their business needs are.”
Though National Financial’s Mirchandani concurs that clearers should zero in on differentiating themselves, he says, that, because “there are only a few firms with meaningful levels of market share, it would be hard to be a specialized player — it’s a business that requires a lot of scale.”
Accelerating the long-time trend to consolidation, new industry regulations will sound the death knell for smaller clearing firms, sources say.