Choosing a clearing firm is one of the very most consequential choices a brand new digital broker-dealer can make. InnReg evaluates clearing organizations using six essential criteria. How will you sound right of the advantages and cons in that high-stakes situation? Here’s how we help our clients navigate this complex process.
Choices and implications
Clearing firms provide the underlying glue to transactions between customers of brokerage platforms and the securities markets.But they are not all created equal. Broker-dealers need to pay special focus on choosing a clearing firm, as it represents the most important element of its operational and technology stack.
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1. Your Clearing Firm’s Compliance BACKGROUND
We always tell clients that the clearing firm’s own internal compliance processes should be the primary area of focus. No one should take these for granted.
Due diligence to confirm any regulatory complaints and actions against a prospect clearing firm must come first. The raw number of issues matters lower than the existence of a pattern of SEC or FINRA issues concerning a specific area of compliance.
2. Cost, Revenue-Model Options, and Fee Structures
For newer entities, clearing companies created to serve institutional or high-net-worth segments may simply be very costly.
Just as important, many of the more established players are wrestling with migrating from legacy systems to more modern technologies or will take a more conservative approach to the types of business models they will support. There’s a reason that such players are seen as the major industry incumbents, and I have great respect for the functions they offer.
Paradoxically, larger firms’ strengths may make them a rougher fit for the precise objectives of a technology-first broker-dealer. Factors such as commissions, fully-paid lending, interest sharing, payment for order flow, and trade bunching donate to the complete value of the relationship with a clearing firm.
3. Transparency
Does the clearing firm offer end-to-end visibility in virtually any given element of the service provided, and also to the extent that you need? Does that visibility support compliance with broker-dealers’ regulatory requirements, and help execute on mid- and back-office tasks with the speed and efficiency that end users expect? Will it provide Know Your Customer visibility across all transactions, and validate any efforts to attain air-tight prevention of money laundering?
4. Underlying Technology
Technology leaders may offer transaction data right to a broker-dealer’s systems, in or near real-time, via modern, easily consumable APIs (Application Programming Interfaces). Basically, these allow the clearing firm’s services to be consumed by systems and applications seamlessly.
More modern APIs do so in real time. Some will be an improved fit for a given broker-dealer’s systems than others, and some might not exactly have the ability to support a complex technology integration to the amount that is needed.
Furthermore, clearing organizations vary widely in the level of automation they support. If their internal trade processing is highly manual, they can not effectively support an electronic digital correspondent. Conversely, others offer full, turnkey automation.
However, the features of a practically instantaneous deployment come at a price. Ready-to-go white label platforms tend to be accompanied by the inability to be customized. This constrains correspondents’ overall flexibility to offer the desired user experience to finish users.
It is important to tread carefully when looking at the real implications of the clearing firm’s automation functions no matter how attractive they seem.
5. Service Model
Does your clearing firm offer compliance tools and integrated alerts, high-quality, meaningful and understandable reporting, and a human being to make contact with when things fail? Does it proactively communicate system or business process issues?
Service levels can, of course, be a trade-off with fees, but it is important to ask the hard questions about precisely what will happen during service issues, interruptions, and failures. These have a direct influence on a broker-dealer’s operations, and the capability to create responses and continuity plans which they can truly rely.
Risk culture considerations sit alongside that service model analysis. Broker-dealers must also be sure that a clearing firm’s risk appetite supports the level of innovation in their business model. It could often be the case that the major institutional firms offer an enormous amount of capital, but it comes with constraints on the ability to offer ground breaking options to get rid of clients.
6. Longevity and Switching Costs
In theory, a clearing firm that can evolve is a better option. As broker-dealers grow in proportions, in the scope of investment options you offer, and even more, they want greater sophistication.
In practice, switching clearing firms is not unusual. Some broker-dealers even switch to a self-clearing model if they have got the scale and resources to do so.
While switching can occur, it is nevertheless challenging or inexpensive. The process of vetting, selecting, and negotiating conditions will need time and internal resources. Under-going a brand new integration process between your technology and the clearing firm’s includes both cost and complexity.
While changing clearing businesses is a logical aspect of any growing broker-dealer scenario planning, it will not be studied lightly.
