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Industry Spotlight > Clearing and Custodial Firms

Scramble for Assets

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Though industry efforts will likely serve to soften the Dodd-Frank Wall Street Reform & Consumer Protection Act that President Obama signed into law last year, it’s certain that, in the immediate future, the financial services arena will be under far tighter government regulation.

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.

“Evolve or die. The question is whether they will be in a position to address their clients’ needs as driven by the regulatory environment and the increased technology requirements to manage that,” Coppel says. “It’s likely that some smaller firms will look for exit strategies.”

Gordon is blunt. He says: “The new regulation requirements will be the nail in the coffin for smaller firms.”

According to Crowley, “You will continue to see smaller players move away from the clearing business if it’s not a core competency of their franchise.  Strategic partnerships may be created where complementary firms will partner up; some with smaller scale will just merge with larger firms.”

It’s a likely bet that no brand-new clearing firm will emerge anytime soon.

“I’d be hard-pressed to think of a startup that, to be competitive, could process millions of trades a year. I don’t think it can be done,” Mirchandani says. “Let me put it this way: I wouldn’t be an investor in a clearing firm that was starting from scratch.”

But one relatively new clearer is notably moving more aggressively into the business: four-year-old LPL Financial custom clearing services, which clears for and provides advisory custody services for seven major insurance-company owned B-Ds, is branching out in pursuit of a variety of customer segments. It is now taking aim at full-service regional broker-dealers and boutique B-Ds, among other segments, all with a primary focus on wealth management.

The strategy is already under way, says David Akellian, who joined the firm in June as executive vice president-head of custom clearing services, in San Diego. Previously with Merrill Lynch and Pershing, he also helped launch the clearing industry in the United Kingdom, where he was based from 1986 to 1991.

LPL’s mission “is enabling the delivery of retail financial advice across the widest possible array of business models,” Akellian says. “But we won’t branch into the institutional or hedge fund clearing segments.”

The firm is engaged in dialogue with a number of prospective clients “to ensure that our product offering matches their needs,” notes Akellian. “If it requires modification, we’ll make minor tweaks to our platform and solutions.”

According to First’s Coppel, the top question B-Ds should be asking themselves about their clearer is: “Am I getting what I need to stay competitive and sustainable, and to continue to maintain a leadership position in the marketplace?’ A clearing firm should enable [B-Ds] to compete effectively: ‘Is mine helping me manage risk and grow my business?’ The clearing industry needs to empower B-Ds with tools and skills to meet the needs of the evolving population it serves,” he says.

To satisfy the stringent advisor disclosure and documentation requirements en route, First Clearing has embedded a special contact management component into its technology that’s a repository for documenting information exchange between client and advisor.  The firm is also piloting a business-planning tool allowing FAs to analyze each client relationship to determine the best alignment of advisor skills with client needs.

National Financial has invested heavily in technology in advance of the new regs. Over the next few months, it expects to roll out a comprehensive strategy, called Catapult, devised to increase broker-dealer efficiency. The firm is also holding workshops on what clients can do right now to strengthen their compliance platform to accommodate the new rules.

Addressing risk mitigation, Pershing, allocating big dollars to developing new regulatory and compliance tools, has an integrated surveillance tool embedded in its platform enabling quick and efficient trade surveillance. Says Crowley: “We’re broadening our offering beyond just the core services — to include, for example, AML [anti-money laundering] checking — and where we can create efficiencies for B-Ds and RIAs.”

RBC has an advanced system, dubbed Protegent, that enhances B-Ds’ capabilities in performing surveillance and supervision. Rollout was set to start this summer.

Thinking Socially

On a different note: clearers, ever on top of new technologies, are launching social networking apps for introducing B-Ds. The rationale?

“This will help our clients attract the new generation of investors. They can share all their investment ideas with their friends — what they’re doing with their portfolios — in a safe, secure environment,” Pershing’s La Salla says. The firm is now at work on such an app.

To be sure, the clearing space, with its limitless parade of innovations, not only keeps up with change, it creates change.

“In any aspect of our industry, but particularly in the clearing business,” Coppel says, “to expect things to be the way they used to be is a formula for disaster.

“You might interpret consolidation as a kind of shrinking, but the reality is that we probably have more clients who need help than providers to serve them. There’s a convergence of the intense regulatory environment driven by the needs of consumers who’ll require the availability of more resources. We view that as a win,” Coppel says. “We’re moving away from the you’re-only-as-good-as-the-last-product-you’ve-sold mentality. Clients need and want more advice.”

He continues. “On the horizon, we see the demand for fully disclosed clearing to increase — and largely because of the regulatory burdens that are being placed on the industry going forward.”