Creative Planning President Peter Mallouk. Creative Planning President & CEO Peter Mallouk

Creative Planning President & CEO Peter Mallouk says the RIA he leads works with all four large custodians — Schwab, TD Ameritrade, Fidelity and Pershing — to service its over $50 billion in client assets.

The a popular industry speaker and author, who’s been head of Creative Planning for the past 22 years, sees many shifts ahead in the clearing and custody business — and for the advisory business overall — as a result of the Schwab-TD Ameritrade deal. He reflected on some developments that came before the $22 billion transaction and its implications in a recent interview with ThinkAdvisor.

“When TD bought Scottrade [in 2017] and then Schwab [said last year it would buy]  TD, that really dramatically changed the landscape, and in the middle of at all that and you thought, ‘maybe E-Trade’s going to come out of nowhere and become an option.’ But technology-wise, they just never got there. And then they got bought by Morgan Stanley,” explained Mallouk.

In terms of RIAs’ view of their biggest options, it looks like they now have “really got Schwab and Fidelity, and a lot of places would like to have a third bucket,” he said. “So [Schwab’s deal with TD Ameritrade] does open the door for another [large] competitor, whether it’s Pershing or someone else.”

Earlier this year, Pershing lowered its minimum asset level for RIAs to $100 million from $250 million and gave its RIA clients two more options for how they pay for custodial services — a zero-commission model tied to a low-yield cash sweep program and a plan that charges at least $25 a month with fees tiered to assets.

With most RIAs managing less than $200 million, those competing with Schwab and Fidelity “need to move downstream” to capture that part of the market, Mallouk said. “And it just naturally seems like if there’s only two major players, you’ll probably see them raise the minimums, so they can encourage consolidation and have less firms to keep track of.”

Explaining the motivation of such a move by the biggest players, he asked: “[If] you’ve got thousands and thousands of [RIA] firms, why not raise your minimum and have to deal with 20% less firms with [about] the same assets?”

The advantage with this strategy, Mallouk added, is that “it’s just less everything — less cost, less risk.” Also, he noted, the more traditional industry players are not likely to lower their minimums to $50 million or $25 million.

While there could be some interesting developments among those firms willing to work with RIAs with under $100 million of assets, “the real door opener is going to be the self-custody places,” the executive added.

‘The Squeeze’ Begins

At the RIA level, “We’re in the beginning stages of the squeeze, and … people don’t realize they’re about to be squeezed,” according to Mallouk.

“You saw this with mutual fund commissions, with mutual funds fees and then with ETFs. [It’s happened] with custodial trading fees, and now you’re seeing it with advisors,” he explained.

What’s playing out “is this demand for technology, strong personal relationships, extra services and value, and more control [that is] moving to fewer custodians,” Mallouk said.

“All of those things put together are going to resolve the great squeeze in the RIA space,” he noted. “But … 18 months ago, [Schwab and Fidelity were] competing with TD Ameritrade … and E-Trade, and now essentially all of that’s gone.” (Scottrade was gobbled up by TD Ameritrade in 2017).

As a result, “a lot of the power has shifted back towards the custodians,” Mallouk pointed out. In addition, compliance and technology requirements are increasing, as is the demand for financial planning.

“You’ve got to deliver for your [RIA] clients without raising their fee,” he explained.

“Soon you’re going to see the custodians impose their requirements, whether it’s basis point fees for their own cybersecurity or [other issues] … that are going to further drive the expense for these smaller [RIA] firms and encourage them to consolidate.

“I don’t see a future where custodians tolerate working with” smaller RIAs, Mallouk said. “It’s just that interest rates are too low. If you think about where the incentive is for the custodians, they’re not making money on [cash sweep] money like they used to. And they’re not making money on trading like they used to.”

Schwab derived nearly 60% of its total net revenues in the first half of 2020 from net interest income. NII totaled about $3 billion in the six-month period (down 10% from the same period in 2019), while overall revenues were roughly $5.1 billion.

At TD Ameritrade, net interest income in the first six months of 2020 was $635 million, accounting for about 20% of its $3.1 billion of total revenue. Its NII dropped about 15% from the prior year during this period.

With NII and trading revenues down, it’s possible that some custodians might ask RIAs clients to pay three basis points, for instance, to cover costs tied to a surprise audit. “They could say, ‘You’ve got to pay for a cyber security audit [and for] using all the vendors we’ve approved … ,’” he explained.

For RIAs, “all these costs become a burden that forces consolidation,” Mallouk said. It’s happened in other industries “very, very fast, and we’re going to see something similar happening here.”

Plus, investors are being given plenty of technology-based platform options, putting further pressure on RIA firms. “That’s just another squeeze on the middle market on top of everything else that’s squeezing them to begin with,” noted the president of Creative Planning, which has about $55 billion of client assets.

Thus, the industry “will see all of these forces conspire together to accelerate what we’re already seeing, which is some consolidation — eventually followed by more and more market share moving to the larger firms,” he explained.

At present, about 50 RIA firms “out of thousands and thousands control the majority of assets,” according to the Creative Planning executive, and that situation “is going to change even more … at an accelerated pace” going forward.

As RIAs get “further squeezed in the middle,” it pays to be a firm that “really knows your clients and has done plans for all of them, knows a lot about their [particular] situations” and so forth,” he added.

More Players?

As for the large broker-dealers, such as the wirehouses, moving into the RIA space, “They’re eventually just going to all have their own platforms to capture those [breakaway advisors] and have them in their own RIA-type model,” Mallouk said.

The lines separating the two business models “are going to continue to be blurred,” he pointed out. “The only thing that makes an RIA different from a brokerage house is laws and regulations, and those are always changing. So we can have a change that makes us all the same at any point in the future as well.”

As Mallouk was being interviewed about shifts in the RIA industry by Investment Advisor, Raymond James announced the consolidation of its custody and clearing unit and its investment advisor channel into the new RIA & Custody Services Division.

“Why are they doing that? Because of expected growth in independent RIA and breakaway advisors,” he remarked. “You’re seeing this unfold in real time.”

Jeff Berman contributed to this report.