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December 1, 2012

What Went Wrong?

A Clearing Industry Veteran Reviews Two Decades Of History

By Gregory Bresiger

Robert Mumby, who runs Baltimore-based RM Associates, which advises clearing brokerages, has seen many firms in the industry fail. Mumby, who has had stints with J.P. Morgan/Bear Stearns, Alex. Brown & Sons and Cowen & Company clearing operations, is a veteran of the clearing business of more than 30 years. He has seen the number of clearing brokerages dramatically decline over the last 15 years, going from 125 about a decade ago to fewer than 20 today.

Why is this business so Darwinian? [IMGCAP(1)]

Many clearing brokerages have not been able to remake themselves, Mumby explains.

Today, they are expected to do much more than just clear and settle, he says, and if they don't offer a bevy of new services correspondents will go-and have gone-to third-party providers.

The clearing broker's legal responsibility for clients, Mumby adds, is increasing, as detailed in the decisions against Goldman Sachs in the Bayou case. In the case, arbitrators and courts have repeatedly held that the brokerage is responsible for the problems of the introducing broker clients (see CQ&D, Winter 2011). This comes at time when trading volumes are much lower than five or six years ago and the central bank's promise of continued cheap money means margin business produces very little revenue, according to industry observers. Add industry consolidations and poor business conditions to these difficulties, and it should come as no surprise so many firms have gone away.

But Mumby says the current problems in the business are not unusual. He says the latest wave of clearing brokerage shakeouts are part of a series going back to the 1980s. In a Q&A with CQ&D, he addressed some of these challenges and discussed the recent history of the clearing business. He also explained how and which clearing firms will survive and even prosper.

 

CQ&D: You've seen clearing brokerage shakeouts before. Let's begin at the outset of your career. What was going wrong for clearing brokerages then?

Mumby: It was primarily a transaction-based and execution revenue model. Financing was growing as margin debits grew through the '80s because of the market surge that began in 1982.

 

CQ&D: And so there weren't nearly the demands on the clearing firms.

Mumby: Yes, they really just processed the business. And there weren't really as many demands on the introducing brokers. There was also a very clear delineation regarding the business from a legal and regulatory standpoint.

 

CQ&D: The business wasn't as difficult?

Mumby: Yes, you could know your customer supervision delineation was clear and everything was in the hands of your introducing broker.

 

CQ&D: As detailed in Rule 382 of the New York Stock Exchange?

Mumby: Yes, the client and the business being done was the responsibility of the introducing firm. The clearing firm was just a processor.

 

CQ&D: Now, looking at the Bayou decision, everything has changed for clearing firm in its client responsibilities?

Mumby: Yes, that is huge.

 

CQ&D: How?

Mumby: If that burden is officially shifted to custodian and clearing firms, it will utterly transform the business.

 

CQ&D: But isn't that shift taking place now?

Mumby: Yes, it's already a huge burden to be a clearing firm in many ways.