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January 31, 2008

NSCC Awaits SEC Ruling

Utility wants real-time data; brokers say 'get real'

By John Hintze and Gregory Bresiger

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The cost-cutting needs of brokers are clashing with the continuity demands of a utility. That is how the debate is shaping up over a National Securities Clearing Corp. trade-compression plan pending before the Securities and Exchange Commission. Brokerage officials charge the plan is arcane and would hurt them.

"This would be a substantial cost for everybody," says Neil Fitzpatrick, head of retail executions at Chicago's Citadel Investment Group, which aggregates high volumes of orders to execute for brokerage customers.

Trade compression happens when a broker-dealer aggregates hundreds and even thousands of orders to reduce clearing and settlement transactions. This is a critical cost-saving practice, say brokerage officials who are fighting the NSCC move. However, an NSCC spokesman says its trade-compression plan is vital. "We think this would be very good for the trading industry," he says.


The NSCC trade-compression plan was initially filed in March 2006 along with proposed fee changes. The changes describe the vast number of uncompressed orders that would have to be processed. The large number is required to ensure that the NSCC plan remains neutral. NSCC is a subsidiary of the Depository Trust & Clearing Corp., which acts as a central settlement utility for equity trades.

In the filing, NSCC officials argued that the plan would reduce operational and systemic risk. And they argue today that risk results "from trade data not being submitted [in] real time." Firms, NSCC officials add, sometimes "delay trade submission so as to pre-net their trade data." This reduces clearance fees. However, NSCC officials also contend that their plan would give most brokers a break on fees.

The NSCC trade-compression changes, if approved, would have different effects on different kinds of brokers. For example, even though the proposal would dramatically increase the number of trades sent to the NSCC, clearing and self-clearing firms submitting those trades for settlement would see only modest increases in settlement fees under the NSCC's proposed fee schedule.

The same cannot be said, however, for introducing brokerages compressing trades before sending them to their clearing firms. They levy higher fees that are enforced by multiyear contracts.

Those dynamics raise several issues that industry players and SEC staff and commissioners hashed out during meetings in October. Then, the regulators said they were keen on analyzing the underpinnings of the NSCC's proposal and its ramifications for the industry before deciding whether to approve it.

Sources say some subsequent discussions between the parties have taken place. Still, any decisions on the issues, including the potentially prohibitive financial costs that could arise, should be made this year.

Len Amoruso, chief operating officer of Knight Capital Group, unofficially leads the group of 12 or so broker-dealers that participated in the October meetings. He notes that the combination of Regulation National Market System and new technology is continuing to squeeze brokerages' margins and shrink order sizes. These factors mean compression is key in cutting costs.

For example, ECNs are highly efficient operations that have dramatically driven down overall trading costs. They are broker-dealers that tend to compress huge volumes of trades before sending them to their third-party clearing firms. Market center competition has squeezed their margins down to a fraction of a cent per trade. That's a challenge faced by many in the electronic trading.

Cumbersome Changes