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March 1, 2003

Big Is Beautiful in the Clearing Business: Hard Times Are Helping the Heavy Hitters

By Desmond MacRae

Also in this article

  • Big Is Beautiful in the Clearing Business: Hard Times Are Helping the Heavy Hitters
  • Page 2

The bear market has been very good to the super powers of the clearing business.

Indeed, the bigger correspondent firms aren't discouraged by hard times. They are improving services and rolling out new products, challenging small-fry competitors to keep up with their rapid pace.

The trend of consolidation, which is expected to continue, was recently illustrated by two massive deals: The sale of 60-year-old clearing giant Pershing to the Bank of New York (BNY), and the merger of Wachovia's First Clearing Corp. and Prudential Financial's Wexford Clearing.

Pershing's some 800 broker dealer and investment manager customers and its $400 billion in assets, will give BNY a good shot at dominating the securities processing industry in U.S and overseas markets.

Rival firms have noticed. "Pershing is a good franchise that some of the big correspondent clearing firms were interested in," said Joseph Kelly, a senior vice president at National Financial Services, the marketing arm of Fidelity Investment Institutional Brokerage Group.

Kelly's comment underscores why consolidation is winnowing out some of the smaller, more vulnerable players in the clearing industry. The drive to achieve scale is critical.

"We read about consolidation almost every day with regional firms being bought by insurance companies and banks to achieve scale," Kelly said.

Self-clearing requires constant capital flow for funding essential services. That can only come from scale. Capital is needed for the correspondents' own customers' margin balances. It takes capital to operate a major execution center. Some Nasdaq dealers may contract with a correspondent clearer to finance overnight positions. The same small desk may utilize the clearer for executing customer orders in multiple markets and for settling the trades.

Still, there is room for smaller, more specialized players, according to experts. These niche operators often tout their personal services and advanced technology.

"You can call relationships a marketing tool if you like, but they give correspondent clearing firms an important edge in holding existing clients, and gaining referrals from them for new business," said veteran clearing pro Carl de Lisi of Reference Intelligence, a financial technology solutions provider in New York.

Unit Costs

Today there are lighter trading volumes than in previous years. This mean that the unit costs for self-clearing firms are rising. Self-clearing is a fixed expense item for these firms come rain or shine. But that's good news for correspondent clearers because they can pitch the potential cost savings to these self-clearing outfits.

"What we try to do is have our correspondents share in the multitude of revenues their business generates," Kelly said.

Outsourcing frees up some capital for introducing brokers, some of which would have to be spent on a multitude of costs, not excluding disaster recovery.

But what to do when a self-clearing firm wants to retain some control of its clearing operation, but still welcomes the supposed cost savings of outscourcing? How about facilities management? BNY says that works for some of its customers.