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Clearing Firms Extend Their Outsourcing Businesses

January 1, 2007
By John Hintze

In the face of a shrinking customer base and a decline in fees from their core business, correspondent clearing firms are using their technology and outsourcing wherewithal to open new markets and generate revenue growth.

The number of National Association of Securities Dealers member firms fell to 5,111 in 2005 from 5,451 in 1995. The number of registered representatives at broker-dealers increased 30 percent, from 505,647 to 655,832, but that's down from the 2001 peak of 673,822. Yet investment assets are rising, and clearers are in a position to make reps more efficient at gathering and managing investment assets. With more assets flowing through fewer correspondents, retaining each clearing customer is a necessity, and attracting new ones a priority. So clearers are aggressively augmenting their platforms.

To maintain their growth patterns, clearing firms "have to be looking at markets outside traditional introducing broker-dealer relationships, because broker-dealers are not exactly growing in number," said Adam Honoré, an analyst at Boston-based research firm Aite Group.

One factor shrinking the commission-based business is the increasing popularity of fee-based registered investment advisers (RIAs). Some broker-dealer reps are becoming pure RIAs, while others hold both licenses. Either way, a new market has opened up for clearers to help reps in their transition, preferably moving their assets into the custody of a clearer's RIA affiliate.

Fidelity Investments' registered investment adviser group has long been one of the largest service providers to the RIA market. The application that Boston-based Fidelity provides to support RIAs is embedded in the Streetscape workstation, which the mutual fund giant's correspondent clearing affiliate, National Financial, provides to broker-dealers. Because both commission-based brokerage applications and fee-based RIA applications are on the same platform, it is relatively easy for agents with brokerage and RIA licenses to use both.

Mark Healy, COO of National Financial, said Fidelity's goal is to have registered reps rely on its technology as they make the transition to fee-based advisory services. "We're eliminating much of the work behind servicing both of those businesses separately," Healy said.

Fidelity is also pushing information and functions that have been available only over Streetscape to correspondents' retail-client Web sites. By increasing information flow to investors, the aim is to reduce financial advisers' administrative duties in the client relationship and accentuate their advisory roles. Since early November, customers of Fidelity correspondents have been able to view the same aggregated picture of their investments-held at Fidelity and other financial firms-as do their financial advisers. Next year, the clearer plans to add information about clients' mortgages, credit cards and other loans.

"The planner gets a much better view of the customer overall," Healy said. He added that another feature of Fidelity's aggregation service allows for searching for mutual fund breakpoints, which qualify shareholders for lower fees. It also can be used to determine whether assets held at other firms can be converted to the Fidelity platform.

Honoré called the Fidelity offering a "smart business move," but he added that technology that eases administrative tasks and reduces the need for broker-dealer support staff is likely to have more staying power.

Document Imaging

Bank of New York Co.'s clearing unit, Pershing, also sees opportunities in the shift toward advisory services, and its recent revamp of its advisory workstation bolsters RIA sales efforts. Another new offering helps advisers cater to wealthy clients by allowing them to set aside assets for tax-exempt charitable contributions in a donor fund. Looking at new revenue prospects, Honoré said he was most impressed by Pershing's efforts to expand the imaging services it offers to financial advisers, encompassing documents a clearing firm wouldn't normally see. For example, broker-dealer correspondents typically do not send new-account forms to their clearers, but the information on these documents is important to those service providers. Pershing's imaging service allows it to gather this information and convert it to electronic format, so the correspondent can access it from the same database that stores clearing-related data.

"There's a huge market now for imaging and workflow," Honoré said. "But it's so expensive to implement at smaller firms that I think outsourcing the service is a really smart bet on Pershing's part, especially if it can make the process very simple." He added that major broker-dealers such as Merrill Lynch & Co. already convert documents into electronic form by requiring their reps to mail all of their forms to processing centers for scanning. Pershing is offering smaller firms the same benefits.

"It's not just about providing an imaging service, but meeting the record retention challenge and beefing up compliance and risk supervision processes," said Jim Crowley, managing director at Pershing. "This provides the adviser with a more efficient way to do business."

Pershing is also adding services to bolster its clearing business. It has worked informally with a few customers to expand the data it collects for them beyond securities trades, such as in banking and insurance. Pershing will provide a comprehensive view of sales-related data, such as commissions across business and product lines, and by branch and region. "The goal is to consolidate the data into one data warehouse, and then provide consolidated reporting about those activities," said Crowley.

Such services aim to automate tasks that were once performed by reps or by a broker-dealer's own back office. Outsourcing allows correspondents to focus on their core competency of brokering investment transactions.

ADP's Hybrid

In a fully disclosed clearing relationship, broker-dealers outsource most of their back office, while self-clearing firms have tended to outsource only trade processing. Automatic Data Processing launched a hybrid service in 2005 to permit self-clearers to remain that way while outsourcing most back-office functions, such as street-side settlement and the status of fails, and the margin and cashiers desks.

"We think this is a sweet spot in the market right now," said Michael Alexander, EVP of operations at Roseland, N.J.-headquartered ADP, which gained initial traction by selling the hybrid service to retail-oriented TD Waterhouse (now part of TD Ameritrade Holding Corp.) and E-Trade Financial Corp. He added that the service enables broker-dealers to adapt quickly to wide swings in trade volume without having to adjust their own back-office personnel and systems. This flexibility should prove beneficial to high-volume firms catering to institutional customers, and ADP recently signed on such a firm, said Alexander.

On the institutional and professional trading front, Penson Worldwide of Dallas in November announced the acquisition of Chicago-based futures clearer Goldenberg Hehmeyer & Co. The acquisition rounds out Penson's ability to clear and execute trades in futures, options, equities and foreign exchange in light of the growing demand for multi-asset-class trading. Penson is now preparing to accommodate portfolio margin accounts, which are expected to receive Securities and Exchange Commission approval by year-end.

Portfolio margining will reduce the collateral requirements for customers trading in multiple asset classes. "It will increase existing customers' trading volumes, because it will provide qualifying customers with more realistic leverage requirements than current ones, and we think it will create additional opportunities among prospective customers," said Penson CEO Philip A. Pendergraft.

Penson builds much of its technology in-house, as do other clearers and correspondents that support their business strategies with customized and proprietary applications. But not even the largest clearers with long menus of technology services can meet every client need. As a result, clearing firms are increasingly offering their in-house development staffs to clients on an outsourced basis, and Pershing is considering how to offer the services of its software development unit based in India. "We're formalizing the infrastructure around this and plan to offer it more broadly to broker-dealers," Crowley said.

For a clearing firm, the outsourcing of software development is a new way of doing business, but Aite's Honoré pointed out that there are plenty of highly experienced competitors. If Pershing, with more than 1,000 broker-dealer correspondent firms, has an advantage, it's what Honoré described as "the account penetration to talk to all right people."