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June 3, 2013

Survival of the Smartest

What clearing and self-clearing brokers must do to survive and how you know it isn't worth the effort

By Gregory Bresiger

Time to pull the plug on the back office?

The deathwatch and the questions never stop in the clearing industry. Which broker-dealer is next to go? And which firm is next to decide clearing is too much for it, because it takes up too much time and resources and poses too many regulatory dangers?

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It is a consistent theme in the clearing business of late: Firms that stop self-clearing. Firms that stop clearing for others. Firms that just stop operating.

"I know lots of clearing brokerages in this business that are barely holding on," said one industry executive, who declined to be quoted by name.

An industry observer says the costs of the business, which have been consistently rising at a time of increased regulation and declining margins, are forcing most clearing firms to think seriously about long-term strategy.

"Brokerages, especially smaller ones, are under an increasing amount of pressure to think about if they should continue to self-clear," said Doug Dannemiller, a founder and principal of LaRoche Research in Duxbury, Mass. Dannemiller knows dozens of brokerages that fall into this endangered group.

Doug Dannemiller, LaRoche

And the pressure has been going on in the clearing brokerage business for the last decade, with many asking which clearing brokerage will be the next to go and which will decide to stop self-clearing.

The number of brokerages that clear for themselves and others has dramatically declined. Over the past 15 years, the number of firms that clear for others has dropped from 125 to fewer than 20 today, according to Baltimore-based industry consultant RM Associates. At the same time, the number of firms that clear for themselves has also declined-the number of self-clearing firms has dropped to around 270, according to Sanjiv Mirchandani, president of Fidelity Investments' National Financial.

Mirchandani predicts it is inevitable that self-clearing firms will continue to decrease. Although Dannemiller says the number of self-clearing firms probably hasn't gone down that much over the past few years, he agrees that the number of firms that clear for others has declined. And he added that the pressure on self-clearing firms to re-evaluate their back office operations "is huge."

Another industry analyst concurs.

"Those firms will face a lot of pressure. There will be fewer firms that self-clear," said Alois Pirker, research director for the Aite Group. Citing the pressures of increasing costs, he also believes the number of self-clearing firms is going to decline. Pirker says the problem for small to midsize broker-dealers-firms that can't achieve the economies of scale enjoyed by the biggest firms-is both regulatory and competitive.