December 2, 2013

The Clearing Mission: Integrate or Die

Clearing industry veteran Douglas Dannemiller details how firms must make correspondents more productive or join the list of clearing brokerages that are gone forever.

By By Gregory Bresiger

It is a familiar pattern of clearing brokerage failure: First, key clients leave. Then the number of compliance protection programs start to dry up. This is commonly followed by the inability to enter into an effective partnership with a correspondent to help the broker-dealer generate healthy growth rates.

These are the reasons so many fully disclosed clearing broker-dealers have failed over the past two decades.

So says Douglas Dannemiller. He has seen this happen time and time again as an executive inside the industry when he served at Fidelity Investments' clearing arm and outside of it as an observer advising financial services firms. Despite the large numbers of clearing firms that have failed or had to merge, Dannemiller expects even more creative destruction looms ahead for the industry.

What clearing firms are vulnerable?

Douglas Dannemiller: Basically, firms that can't help their correspondents organically grow will die, he warns. And that means going beyond the traditional post-trade and settlement services and becoming an essential part of the correspondent's business. How can a firm do that? Clearing firms, he said, must help correspondents with many pre-trade functions if they are to become essential to clients. They also must be proactive in providing a service such as compliance, which is increasingly important in the wake of new rules. Dannemiller recently discussed these and other clearing issues in a Q&A with CQ&D.

The number of retail brokerages that clear for others has been on the decline since the late 1990s. What is it now?

Dannemiller: About a dozen. Around 15 years ago, that number was more than 100.

And you believe the bloodletting in the business isn't over?

Dannemiller: Yes, I think it could drop think to about seven or eight.

What are the common warning signs that a clearing brokerage is in danger?

Dannemiller: From the outside, the warning signs can be hard to see. You need to go inside and understand their failed relationships with other firms. If sales alliances are breaking down and firms and clients are leaving a clearing brokerage, then the firm is in trouble.

Is it a problem of organic growth? Is the biggest problem that the clearing broker can't help clients become more productive?

Dannemiller: Yes.

And so people leave and that spooks others in the business, who start shunning a clearing broker?

Dannemiller: Yes. The turnover in staff and decrease in the size of the staff. Those are warning sizes for a clearing firm. Another warning sign is the loss of key clients. The larger clients at a clearing firm move elsewhere. That's a signal of a problem; that's a signal that scale is being impacted.

The danger that the firm is losing control, owing to the 80/20 rule. Eighty percent of the business is recorded by 20 percent of the key clients?

Dannemiller: Yes. And when the largest clients leave, that is a sign for the remaining clients that the funding and scale for the rest of the clients are going to be further in question.

But besides the realignment issues that lead some clients to find a new clearing broker, you also believe in your experience that there is a common theme for the dissatisfied correspondent?