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April 1, 2004

The Rapid Rise Of Outsourcing: More Firms Are Throwing In the Self-Clearing Towel

By Desmond MacRae

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  • The Rapid Rise Of Outsourcing: More Firms Are Throwing In the Self-Clearing Towel
  • Page 2

Many financial firms find it efficient these days to outsource trade clearing functions at the same time that there are fewer competitors in this difficult business. And continued consolidation is inevitable, several players say.

"In the mid-1990s, there were probably 135 correspondent clearing groups," says Norm Malo, president of National Financial, the correspondent clearing arm for Fidelity Investments. "Today there are less than 75. In five years, there may be less than 50."

This is happening when demand for these clearing services is on the rise. Most financial firms have now opted to hire correspondent clearing firms. There are roughly 350 firms left in the U.S. clearing for themselves, according to Matthew Bienfang, a senior analyst with TowerGroup.

"I see a final changeover from the self-clearing model, that broker dealers insisted on some years ago, to this new model in which firms outsource as much of their securities operations as possible," Malo says.

Correspondent clearing customers now want these firms to hook them up with front-end order management systems, and have the rest done for them as seamlessly as possible. The idea is to save money by substituting high fixed-costs for the variable models provided by clearing firms.

This intensified move to outsourcing has been paralleled by the changes in ownership of correspondent clearing firms. Bigger firms are now players in the business. Among the notable deals of recent times: Pershing's acquisition by Bank of New York (now regarded as the largest securities processor in the world), and National Financial's purchase of Correspondent Services Corporation.

This consolidation is driven by technological advances. "Automation has allowed a few big players to clean up because they can afford to cost-effectively connect to securities depositories and to the central bank payment systems," says James Coulter, a partner of Reference Intelligence, a small New York-based consulting firm. Nevertheless, the bigger players are usually careful about their purchases.

"When a big firm buys a smaller firm, there is a pretty careful focus on what kind of customers a new acquisition can bring," TowerGroup's Bienfang says. The Pershing acquisition is a good example. That's because the Bank of New York simply did not have the same expertise in the equity business that Pershing had, an expertise the firm has been honing ever since 1939 when it was established, Bienfang adds.

Fishing Business

Little fish will also eat other little fish. "I think you'll also see a lot of little firms merging their operations," Bienfang says. "Some of the little fish know their niche; they are meeting their clients' expectations; their business model is working, so while they need more scale, they don't want to sell."

But some firms will simply drop out because of constant technology costs and the downward pressure on pricing. However, rising volumes in the last 10 years, and expectations of big volume coming from Asia, particularly China, is changing the outlook. There could be more opportunities for success for those willing and able, despite the ever downward price pressures.