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March 1, 2002

The Bear Market Blues in Clearing Worst of Times Could Become Best of Times

By Patricia A . Murphy special correspondent

Also in this article

  • The Bear Market Blues in Clearing Worst of Times Could Become Best of Times

The bloodied clearing business these days is being cleared of its weaker members.

"With the market down commissions have been lower, so everyone is looking at shrinking margins," said Joseph Kelly, division executive of the Institutional Brokerage Group at Fidelity Investments. "Firms that are self-clearing are confronting lower volumes after having built up capacity. With T+1, another large investment looming, some [of these self-clearing firms] are looking closer at a fully-disclosed relationship."

Some suddenly more vulnerable correspondent clearing firms are also paying closer attention to the costs of their correspondents, or introducing brokers. And, still whirling from the down market and decreased volume, several clearing firms themselves are confronting the impending task of complying with T+1.

Surprises are not welcome. It was about 12 months ago months ago when one correspondent clearing firm, May Financial in Dallas, was saved from ignominous disaster. May had a capital crisis when the asset base of one of its introducing brokers was severely damaged. That left May in the lurch until it was acquired by a local rival SWS Securities, formerly Southwest Securities.

Firms have vacated the clearing space, cut overhead by laying off staff or merged with larger firms. Nevertheless, a bear market isn't all bad news. For every clearing firm that closes its doors there is an opportunity for another to gain clients, according to industry experts. That's because hard times have led some desks to take another look at the relationships they have with their current clearing firms. Clients are becoming more finicky. They want cost savings, the best technology, straight-through-processing, or STP, connectivity, superior customer service.

By turning to STP methods, trading firms can reduce costs and maintain volumes with smaller staffs. Clearing firms that have made the investments in technology are ready and willing to help their correspondent clients transact in the real-time world.

But clearing firms should be realistic about obtaining new business in these bad times. There will be a limited opportunity to expand relationships with the biggest desks.

While many dealer desks handled much of their own clearing functions, especially on the Nasdaq markets, others have correspondent relationships with clearing firms for an array of specialized and capital-intensive functions: financing margin accounts, sweeping money into money market funds for its retail operations; executing orders in mutiple markets a desk does not cover; financing overnight balances. There are numerous other services. The largest desks at the biggest firms need fewer of these services. And effectively competing today in this kind of business has dramatically changed.

More Demands

Within the past few years clearing and executing trades has evolved from an end of the day process into a real-time, electronic environment. As such, correspondent clients continue to demand more of their clearing partners.

"The issues that our clients are coming to us with involve trading seamlessly with buyside clients, accepting messages from them electronically, sending those messages to execution venues effectively and managing the entire process on a straight through basis," said Peter Farkas, director of institutional services at Pershing. Watching the bottom line closely, trading firms push for straight- through-processing as a means to reduce costs.