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Industry Spotlight > Clearing and Custodial Firms

How Clearing Firms Embraced Innovation

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The anticipated hike in interest rates will bring a windfall to clearing firms. Clearers certainly haven’t pinned their strategies for the past five years on that eventuality. Even so, a move to increasing rates from the historic, and enduring, low level will be a very big deal indeed.

Post-meltdown, clearing firms have compensated for lost interest revenue and declining margins mainly by raising miscellaneous fees and ticket charges, and realigning expenses. By adjusting their business models, some firms have virtually reinvented themselves.

“In a zero-rate environment, we’ve transformed our business in the way we’re operating and investing. Today, you can’t be dependent upon an interest rate increase to have sustainable margins. That’s a flawed strategy,” says Jim Crowley, chief relationship officer of Pershing, a BNY Mellon company based in Jersey City, New Jersey, and with about 1,500 clients, the No. 1 clearer.

Neither has National Financial, the second-largest clearing provider and numbering 500-plus clients, been holding its corporate breath hoping for rates to rise.

“I’m not counting on [an increase soon], though if that were to happen, it would be good for the business and the brokerage [industry] overall. But I’m never optimistic about interest rates because it’s so easy to be fooled,” says Sanjiv Mirchandani, who was named president of Fidelity Clearing and Custody this past February, when Fidelity Institutional combined those two units. He was formerly president of National Financial.

For the last six months, clearers have been busy introducing and integrating more and more technology to support their BD clients. Central to such efforts is a major thrust to help advisors digitize their businesses.

In the fourth quarter of last year, National partnered with robo-advisors Betterment Institutional and LearnVest. Then, in February, Fidelity agreed to acquire eMoney Advisor, a leading financial planning software company, now part of the newly created Fidelity Wealth Technologies group.

National is enhancing and integrating eMoney with its clearing platform to “make it much easier for advisors to go from financial planning to investing,” Mirchandani notes.

For the most part, clearing companies are embracing what is becoming the increasingly important robo-advisor model, deeming it complementary, rather than adversarial, to the traditional full-service advisor.

Pershing prefers to use a broader term, “digitally enabled,” of which, Crowley says, robo-advisor is a component. “We don’t think of [robos] as a threat to the business. We’re helping our clients to digitally enable their platforms to be more efficient with account opening, CRM systems, financial planning tools [and so on]. We’re building a platform that will digitally enable our clients to meet the wide range of strategies that they have.”

Some see a parallel between robo-advisors and 1990s dot-com companies or with online brokers when they first emerged.

“A lot of [dot-coms] launched, but not all were successful. At the same time, you couldn’t ignore the Internet—it changed everybody’s business,” Mirchandi points out. “[Robos] are something that we can benefit from and not just see as a threat. If traditional advisors would embed some of their best practices, like more automated processing of smaller accounts, and embrace the technology that’s driving them, and power their businesses with more of that, they’d become even more productive and valuable. This could be an answer to how to make money on small accounts.”

Another reason for folks to enthuse about robos is that they bring transparency to pricing by allowing clients to compare FA price and performance. It is therefore imperative for advisors to determine and hone their individual value propositions.

“The robo-advisor is a good thing for the industry, broadly,” says Brett Thorne, COO of RBC Correspondent and Advisory Services, in Minneapolis. The unit serves about 200 clients. “[Robos] allow broker-dealers and advisors to more efficiently serve a smaller account that doesn’t need trust and estate services, for example. So this may be a great solution for those clients. It’s cost-effective for advisors to partner with a robo-advisory-type offering and still stay connected with accounts, as they [consider] appropriate.”

Getting an Earful

One clear advantage that traditional advisors have over robos is the ability to communicate with clients verbally and especially face-to-face. But in this department, many FAs need a tune-up or, in some instances, a total overhaul. And here, clearing firms are trying to be of service too.

“Listening skills are the No. 1 communication issue that advisors need help with. We work with them on ‘active listening’ to understand what the client is saying without interjecting their own point of view,” says William Coppel, managing director and chief client growth officer at First Clearing, an affiliate of Wells Fargo, based in St. Louis. It has 75 clients. Training in active listening is part of a range of programs the firm offers to help improve FA communications skills.

“The financial services business has always been about telling clients what they need to do,” Coppel says. “The shift is toward having empathy and the ability to understand what clients are looking for and what’s important to them.”

First Clearing’s recently released white paper to help advisors reach female clients focuses on “how women want to be treated,” Coppel says. “The industry lacks skills to serve the women’s market well.”

A thought leadership piece published by Pershing in August 2014, “What Do Top Advisors Say and What Do Investors Really Think?” features the financial vocabulary clients hate along with words they’d like FAs to use. For example, a big thumbs-down to financial jargon: “Fiduciary” is out; “advocate” is in. Investors like “comprehensive” rather than “holistic,” and they really respond to “emotional language”: “passionate” over “committed.”

Clearing firms’ talent for reinvention stems in large degree from the demands of new rules and regulations that have been imposed following the financial crisis.

“It continues to be daunting,” laments Coppel. To comply, the regs require additional substantial technology investment by both clearing firms and BDs.

A new FINRA proposal, for instance, calls for a Comprehensive Automated Risk Data System (CARDS) to regularly collect account information and activity, along with security identification info that firms maintain.

“This is looming. It’s very costly to [BDs] and the clearing firms,” Thorne notes. “But we have to adapt to the regulatory environment and technological advances. Keeping up with that innovation is very expensive—though, at the end of the day, the advisor and the consumer both win.”

High-tech investments, the increasing cost of compliance and heavy outlays for advisor recruiting, too, will bring further consolidation to the shrinking clearing space. Though typically manifesting with smaller firms, one top-tier player with large accounts removed itself from the fray last February, when J.P. Morgan agreed to transition clients from its broker-dealer services platform to National Financial. J.P. Morgan continues to self-clear for its own broker-dealers.

The bank declined to comment, but a source familiar with the decision says that “shedding the broker-dealer services business was part of J.P. Morgan’s overall simplification effort to focus resources on core business and strategic growth opportunities.”

The firm’s clearing business was the legacy Bear Stearns’ broker-dealer service, which became a subsidiary of the bank with its 2008 acquisition of Bear Stearns. Now BD clients must decide whether or not to sign up with National.

“It’s a difficult fit because J.P. Morgan’s mantra was ‘How can we serve our direct clients?’ The thought of making their intellectual properties and operational expertise available to potential competitors was counter-culture to them,” opines another industry observer not authorized to speak to the media.

He continues: “It was a great acquisition for National, but it will be interesting to see if the broker-dealers that cleared through J.P. Morgan will feel at home with National, which is more of a mass market, direct-to-consumers firm. Bear Stearns, prior to its demise, was one of the big gorillas on Wall Street. Clients will vote with their feet.”

For National’s part, Mirchandani says: “This is a big project for us and a work in progress. We’re in active conversations with these firms. It’s going very well.”

Some speculate that more consolidation could occur in situations where clearing is only a minor part of a large bank’s business.

Still, it is the discrete smaller firms that are more likely to exit the space.

“Some players may try to sell their businesses, though that certainly won’t be at the pace we’ve seen earlier. There aren’t as many clearing firms anymore, so there’s not much left to consolidate,” Thorne notes.

Security Alert

As it is for businesses in general, cybersecurity continues to create headwinds for clearing firms.

“Maintaining security of individual client records and information about investments is a top priority,” Coppel says. “A lot of energy and investment is being made in this area.”

In their mission to help BDs, firms remain committed to generating a steady stream of new products and services. For example, RBC just brought out a fixed-income portfolio analysis toolset and another for alerts; the latter allows FAs to receive message alerts of developments that could impact portfolio holdings and warrant their adjustment. Pershing last January introduced a Retirement Plan Network program that connects advisors with employee retirement-plan record keepers and administrators on a broad scale.

In time, unpredictable events will no doubt spark the clearing arena’s further reinvention. For decades the space was limited to processing and settling trades, and custodying assets. Now, in addition, the firms offer supermarkets of investment products and services, plus home office tools and services like business consulting.

Indeed, clearers have become increasingly solutions-oriented and consultative. In the latter effort, they’re accenting FA relationship-building. This is particularly critical when it comes to Generation X and the millennials, who as a group are expected to receive some $30 trillion in assets from their parents and grandparents over the next three decades.

Here, again, clearers are giving BDs a firm nudge in the right direction.

Crowley says: “If [BDs] aren’t positioning themselves to help their advisors build relationships with the next generation of investors, they’re going to lose out on what could be the greatest opportunity in the next 30 years.”


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