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There was a trader article in 1998 that said liquidation remained a lucrative business for well-financed broker-dealers.
What will the clearing industry look like in 2022? Does it remain lucrative? According to Brett Thorne, president of RBC Clearing & Custody, competitive pressure and the commoditization of trading services “keep margins low.”
“But with the right scale, the right technology, and perhaps just as important, the right people, clearing can be profitable for a well-managed clearing provider,” he said. rice field. Market capitalization can be an important consideration, especially during periods of market volatility, he said.
Will Thomey, co-head of business development at Acadia, added that profitability depends on perspective. The clearing business of many major financial institutions is considered a vital business that fully supports their customers, but the profitability of these businesses is not always as favorable as in other areas.
He believes that more successful clearing brokers enable scale, seek improved collateral optimization, understand the relationship between cost of capital and how franchises operate, and develop client-specific arrangements. It added that it is investing in technical and operational capabilities (both commercial and operational) to minimize it. Be an effective risk manager (prevent potential losses from default or operational error).
“There is currently a tailwind for the clearing business as macroeconomic conditions lead to higher trading volumes and higher interest rates (which typically lead to an improvement in NII),” he said.
A spokesperson for Apex Fintech Solutions said clearing houses can generate a decent return on capital if done right. For a clearing company to be successful, it must have superior processing tools that can be scaled in combination with the expertise of its employees, ensuring that regulations are adhered to and customer assets are protected.
“Companies must continue to innovate to provide their customers with products and solutions that provide a frictionless investment experience.”
1998 saw a trend toward consolidation in the clearing space. Twenty-four years later, in 2022, Thorne said consolidation still seems to be a trend and a constant topic of conversation among broker-dealers. “We do not expect the consolidation trend to slow down anytime soon as the cost of doing business continues to rise, the regulatory burden continues to increase and the challenges of running broker-dealers continue to increase,” he said. emphasized.
Another related trend, Thorne said, is that many independent financial services providers are giving up on broker-dealers and switching to a registered investment advisor (RIA) business model. “This is due to the very same pain points that compel broker-dealers to consider consolidation. So being able to provide a custody solution is becoming an important service offered by clearing providers,” he said. Told.
The power of the workplace, which is driving consolidation and the shift towards serving clients as RIAs, is due to two hiring trends seen across the business world since the pandemic began: the war for talent and the It’s fueling rising labor costs, Thorne said. “Clearing operations rely on employees with highly specialized skill sets.”
Thorne argued that the trend with the most far-reaching impact could be that “technology is playing a bigger role than ever” in day-to-day operations and the way services are delivered across the financial services industry. did.
“Clearing firms are becoming the go-to source of tools and systems beyond just providing trading support and maintaining books and records,” he said.
Thomey agreed, saying that operationally there is a more coordinated effort to improve automation. As market silos continue to erode, firms recognize that even though the cleared OTC/F&O market has an element of standardization, the operating environment should be simpler (especially compared to non-cleared OTC markets). he said. “However, investments in automation have lagged behind, decoupled infrastructure/processes, restricted workflows, and customer/clearing brokers across trade (or position) management, margining, and settlement. We need to digitize the interaction between / exchanges / CCPs,” he said.
Furthermore, Thomey said given the macroeconomic environment of the past few months, increased volatility has re-emerged risk management as an industry-wide focus. “This includes examining the levels of margin/collateral held (and associated initial margin models/calculations) and default management practices across the industry,” he said.
A spokesperson for Apex Fintech Solutions said the biggest challenge for CCP is the continued demand for real-time processing. “Not long ago, it took him five days to settle a stock trade. Now he has reduced it to two days, and plans are underway to bring him to one day by 2023.”
“We are also beginning to see a growing demand for 24/7 trading in traditional markets, as is the case with cryptocurrencies. We need to continue down the road, as this style of trading feels inevitable at this point.”
According to Thomey, there are various challenges, mostly related to disparate data. Clearing brokers have to deal with inconsistent data representation across exchanges or CCPs without having a form of standardization on connectivity (e.g., the industry lacks standard APIs), he said. Told.
“This poses challenges in managing trades (properly executing, allocating and clearing trades), reconciling ongoing books and records, and maintaining reference data (commodities, risk arrays, etc.),” he said. I was.
Additionally, according to Thomey, clearing firms are subject to different operating models required to post collateral on exchanges or CCPs. “This operational drug leads to suboptimal collateral allocation,” he said.
He added that replicating margin calculations is complex (given the differences between exchanges/CCPs), further complicating the ability of all participants to optimize risk and reduce associated costs. I was.
Thorne argued that keeping up with the technological changes happening in financial services is a “huge problem” for many clearing firms. The challenges, he said, fall into three categories: cost, connectivity and capacity.
Developing new technology, adapting off-the-shelf technology, and decommissioning legacy technology can all require significant technology budgets for financial services firms, Thorne said.
“The faster a technology goal needs to be met or the more complex the work to achieve it, the more money a company has to spend. We are looking for ways to help and reduce technology costs,” he said.
Beyond the underlying issues related to technology development, Thorne added, there is the challenge of how financial firms integrate new solutions into their existing technology stacks. Technology is meant to help make tasks easier and improve results, but if tools don’t communicate with each other, instead of simplifying the user’s task, “technology causes headaches.” could become,” he said.
“Clearing firms need to provide technology platforms that are flexible enough to work with different systems,” he added.
Another challenge, Thorne emphasized, is the impending generational change in the financial industry.
He explained that with the imminent retirement of many key figures in the industry, company management is shifting to younger leaders and younger producers need to enter the business.
“For these next generation company principals and financial professionals, technology could be the deciding factor in who they choose as their clearing provider,” he said.
“They offer clearing provider technology that helps strengthen client relationships, including plans for mobile access to software and account information, and self-service offerings that enable clients to save, invest, and spend money more easily. We are looking for a service function,” he added.
Improved accessibility for clearing
As the securities industry continues to evolve, Thorne recognizes that the risks of serving small businesses may be greater than the potential returns generated by smaller firms, so some Clearing providers said they were pulling out of smaller broker-dealers.
“In terms of improving accessibility, clearing providers need to do a better job of balancing the rewards and risks of serving smaller broker-dealers,” he said. .
In support of this point of view, RBC Clearing & Custody works with small businesses that can demonstrate a strong track record in managing business risk and running a clean business.
“Certainly, we see many advantages in working with smaller broker-dealers. They know their personnel well, so having high-quality financial professionals with fewer compliance issues.” Plus, many profitable small businesses have talented staff with low turnover,” he said.
A spokeswoman for Apex Fintech Solutions said increasing the accessibility of clearings for introducing brokers, non-traditional firms, and individual investors themselves will be done by providing a “frictionless experience.” I was. Providing turnkey and integrated platform solutions to these entities and their customers for a seamless experience, leveling the playing field and empowering everyone with tools to access markets and accumulate wealth A spokeswoman said it was a clearing company that could allow it. “It will lead to a better experience, coupled with continued education for industry insiders.”
Mr Thomey pointed out that clearing brokers (and exchanges/CCPs to some extent) need to be well-capitalized entities with a good “skin in game”.
“Accessibility improvements should not be made where there are trade-offs (i.e. lower or lesser levels of margins or capital) or where there is less scrutiny from global regulators,” he concluded.