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December 20, 2007

Clearer, Clearer on the Wall. Who Has the Fairest Model of them All

Clearing Quarterly & Directory

By Gregory Bresiger

Two competing clearing models are battling for the hearts and minds—and the business—of the institutional clearing client.

One model uses numerous vendors. The best clearers don’t do it all in-house, this odel’s supporters say. They farm out some technological and trading functions. They use vendors, but demand much of them, according to advocates of this model. A clearer that makes vendors compete so that correspondents can receive updated trading
functions provides the best service for the institutional broker, they say. Examples of this model are National Financial Services and Pershing LLC, a unit of the Bank of New York Mellon.

“If you have five vendors all competing for correspondents, then those five vendors are going to be constantly adding new functions, keeping up with demand because they know that, at any point in time, that institutional broker has lots of choices,” says Bob Mahoney, a vendor. Mahoney heads institutional trading for online brokerage thinkorswim and was formerly chief executive of OMS Arrowhead Solutions, which was
bought by thinkorswim.

But others argue for a different clearing model. They think a clearer should have the experience of clearing for its own traders and have its own proprietary systems before it clears for others.
They believe the institutional broker needs a clearer that has the capacity to do everything in-house. And this model is superior to one that uses many vendors, a Knight Equity Markets official contends.

A Key
“It is very important to us in a clearer that he doesn’t have to go outside to clear any portion of our business. That is certainly key,” says Frank Grampone, managing director, head of operations for Knight Equity Markets, which uses Merrill Lynch clearing subsidiary Broadcort Capital Corp.

Grampone was recently approached to switch clearers, but didn’t. Why? The clearer, which he declined to name, used lots of outside vendors, which Grampone feared would lead to problems when his firm had any unique issues.

A clearing official whose business is now primarily retailoriented agrees with Grampone’s assessment. “The key to selecting the right clearing partner is to partner with the firm that is really in the business that you’re doing, not supporting the business you are doing,” says Craig Gordon, president of RBC Dain Correspondent Services.

Gordon contends that NFS and Pershing are not the best for the institutional broker because they frequently outsource, lacking institutional expertise (see related story page 9). He also asserts that they claim their platforms support every possible kind of client. “You’re catering to everyone, but servicing no one really well,” Gordon says.

Clearers, brokerage officials and their clients debate these two different models every day in deciding whether to retain or find a new clearer. Pershing and NFS, the 800-pound gorillas of the clearing business, use many vendors, including thinkorswim, Reuters and various OMSs. Internal competition, thinkorswim’s Mahoney says, is a good thing.

Clearing officials who agree with Mahoney say those firms that can perform most clearing functions in-house have greater leverage over clients because the system is the one they must use.
Still, the vendor model also has its critics. They complain that the Pershings and National Financial Services of the industry are subject to a grave disadvantage: Their trading and clearing systems were developed for retail clients. Examples of firms that can do it all for institutional clearing clients are Bear Stearns, Goldman Sachs and Broadcort.

But an NFS official stresses the advantage of her model: It is more client friendly. Many of her clients insist on using outside services, partly because clients have both institutional and retail business. Anne Steer, executive vice president of relationship management for National Financial Services, says to force correspondents to do everything in one place would
alienate them.

“We have found that many of our clients have an incredible affinity for their OMSs and their ways of working. So frankly, our business grew out of our clients and the ways they were building their institutional businesses,” she says.

Most clients, she says, don’t want a full clearing package. “They are quite firm in saying, ‘Accommodate me. Work to integrate the systems that I am using today,’ ” she notes.

The most common reason for this, Steer says, is that clients have existing relationships with an OMS before they come to the clearer and they want to continue them. Pershing officials generally agree. They note that, through vendors and third parties, they can tailor technology solutions for their clients.

“For us, it’s about choice,” says Jim Crowley, a managing director with Pershing who works on business development.  “It’s about open architecture and about being a solution provider.” He also notes that the vendor model has pluses and minuses: “We don’t have a proprietary ax to grind, and some folks who do can sometimes outbid us for the business. And that’s just the way it works sometimes.”

An official of Pershing’s financial technology partner Neovest says the vendor concept is “clearly superior.” Mike Trezza, director of sales for Neovest, says it is more flexible. “Different clients are going to want different platforms for different reasons, so why force them to use something that may not work for them?” he says. Trezza says even the biggest
clearers are also using Neovest, which is owned by JP Morgan. “We’re actually working with all of the clearing firms, but it is only Pershing and National Financial that proactively work with us and consider us one of the vendors that they recommend,” Trezza says. The institutional broker can receive Neovest services directly from Pershing, Trezza explains. NFS just recommends Neovest, which still has to sell the service to the client.

Mahoney, who praises both the NFS and Pershing models,warns that clearers that have an institutional system—which have everything in-house—can take clients for granted. They may be reluctant to add new functionality “because they know they have you hook, line and sinker,” he adds.

Nevertheless, Knight officials say that’s not case with Broadcort.


Grampone says Knight was approached by another big clearing firm, but it rejected the offer. Why? It lacked a proprietary system. Also Knight officials feared the clearer might not be able to satisfy some of its clients. “Knight’s institutional offering is a major part of its business,” says Knight’s Grampone. “Therefore, it is imperative that our agent provides post trade processing clearly and accurately.”

Clearer compatibility for Knight means working with its front end trading system as well as its proprietary order handling and execution systems.
“The reason why Knight can react quickly to our own clients is because we have control of our systems. I don’t have to go outside to a third party and ask them to make a software change,” he says. “We’re very familiar on our own end, and we look for that in a clearing agent, as well.”

On one level, the debate over the models is academic, because advocates on both sides agree that there are certain key issues that are critical to success, no matter the model.  These include access to market data, providing OMS solutions and trade reporting. But most importantly, personal service, or the lack thereof, can ruin a relationship, leaving the correspondent ready to take the radical step of changing clearers. What can prevent that?

“The client wants to be sure that they are dealing with people who understand the business not only from a trading perspective, but also from an operations perspective,” NFS’s Steer explains. That means product and trade support, which includes the different needs of an institutional versus a retail client.

“In order to mitigate exposure and risk, the clearer must address problems very quickly,” says Grampone. “How quickly do they turn something around?” And thinkorswim’s Mahoney asks, “Are they doing what they say they’re going to do on the date that they say? Is all functionality as advertised?”

Grampone adds that a clearer must have a dedicated account representative available all the time. When there was a recent trade file problem, Broadcort officials were “on the phone with us through the night.”

Steer says that NFS is attempting to improve accountability through its newly formed institutional advisory council. It also wants the council to work with institutional clients to assure that the firm’s vendors are responding to their needs. But primarily, she adds, it is the responsibility of NFS to do its own “due diligence regarding its vendors.” Bad vendors or a one-stop clearer that takes the correspondent for granted will destroy a relationship, officials agree.

Having recently gone through the aforementioned trade-file problems, Grampone believes that day-to-day service is the end-all, be-all of how institutional businesses judge clearers—whether they use vendors or not.

“Anything that would create a situation in which my client would be affected is important,” he says. Service trumps even pricing, Grampone argues, because “one can’t put a price on a lost client or the damage to your reputation because you failed to clear trades effectively.”