Making Alliances Work

Clearers Help Clients to Find Better Vendor Solutions

Among other things, clearing firms must be good intermediaries in arranging outside services for clients. Although ticket charges and services are still very important when deciding on a clearer today, there’s an increasingly critical factor in the specialized clearing business: Even some of the 800-pound gorillas of clearing don’t do it all, so they must farm out some services to vendors and third parties.

And that, says a veteran sellside order management system executive, is when the clearer-correspondent relationship either strengthens or crumbles. Bob Mahoney is managing director in charge of the institutional trading division for online brokerage thinkorswim. The firm offers front-end platforms for electronic trading of equities, options, futures and other financial products.

Mahoney, in directing thinkorswim’s institutional division, oversees strategy for thinklink. That’s its order management system, which, according to some estimates, has roughly 200 installations. The company won’t comment on that. Mahoney also oversees thinkpipes, an execution system for the buyside and broker-dealers. He says clearers must be very careful where they send their correspondents.

Mahoney is the former chief executive officer of OMS Arrowhead, which was acquired by thinkorswim. He says vendor service can be a critical factor in whether a client remains with a clearer or goes elsewhere. He recently discussed these issues with Traders Magazine.

TM: What are institutional broker-dealers looking for today in a clearer? What criteria do they use in finding a new one or in evaluating a current one?

Mahoney: First and foremost, the clearer should have a tight relationship with vendors. This is true whether it is with a trading order management system like ours or a market data provider, such as Thomson or Reuters.

TM: What do you mean by “a tight relationship”?

Mahoney: The broker, using a clearer’s recommended third party, won’t be left out on a limb if there’s a problem with a vendor. The broker wants to be able to go to the clearer and know the clearer has some power to make things happen with the vendor.

TM: So in evaluating a clearer, the broker wants to know not only what are the clearer’s capabilities, but the quality of his alliances as well?

Mahoney: Yes. It’s one thing for an institutional broker to go down to National Financial Services (NFS), for example, and say, “I know you don’t have an institutional trading system. Who do you recommend? Who do you have?”

TM: But the clearer must go beyond that.

Mahoney: Yes, it’s a bad thing for the clearer to say, “Here are 10 people on the list. Go call 10. Good luck.”

TM: So the clearer’s responsibility doesn’t end with a vendor recommendation?

Mahoney: Correct. The clearer’s main responsibility is to their client’s needs. They should continue to do their due diligence on the vendor and survey their clients for their level of satisfaction.

TM: So what you’re looking for in a clearer is someone who has quality vendor and third-party relationships with many firms, but who also knows which ones are the best?

Mahoney: For instance, NFS has this kind of tight relationship with some vendors. They have what they call their priority vendor list. And while some other clearers don’t necessarily have these formal priority relationships, obviously they do have vendors they work well with, whom they would recommend over other vendors. So I think, from the broker-dealer point of view, having a vendor that is approved, or preferred from the clearing point of view, is a big plus.

TM: You say these recommendations can be critical because neither of the biggest clearing firms, Pershing and National Financial, have institutional trading solutions-their trading systems are geared for retail. So their recommendations here can be critical to the institutional broker-dealer and how he evaluates the clearer?

Mahoney: Right, the recommendation is extremely important since institutional brokers will not be able to survive using their retail system, since they need more sophisticated tools.

TM: Thus, they have to recommend an outside service. But wouldn’t the institutional broker be better off finding a clearer who doesn’t have to use vendors and has everything the correspondent needs in his system?

Mahoney: Not necessarily, because by not having something, it creates competition. It also could mean you could get the best system out there. If you have five vendors all competing for NFS and Pershing correspondents, then those five vendors are going to be constantly adding new functions, keeping up with demand, because they know that, at any point in time, that institutional broker has lots of choices. If you are going to a clearing firm that has its own institutional trading system, it may be reluctant to add functionality, because they know they have you hook, line and sinker.

TM: You believe that the two giants of the clearing business, Pershing and NFS, are doing a good job. But how can an institutional broker tell that he’s gotten one of the vendors who is on the A team? What should a clearing client check?

Mahoney: Make sure the vendor is keeping up to date with compliance and Reg NMS issues. Make sure they are up to date with all the interfaces the vendor has with the clearing firm.

TM: Everyone says their alliances are superb. How do you test these claims?

Mahoney: I’ll give an example: How quickly do they turn things around? For example, the short exempt rule is no longer around. How quickly has the vendor turned it around and said to the clearing firm: “As of this day, we’re no longer going to be passing the short exempt.” There was a three-month exempt period. Did they take all three months and come in at the last minute? Or were they ready the first week the clearer asked them to do it?

TM: The vendor must also be able to execute a global interface quickly?

Mahoney: It’s all about how fast the vendor can react when the clearing firm says to do something. This will demonstrate which vendors have a close relationship with a clearing firm.

TM: Any other distinguishing characteristics of a good vendor-clearer relationship?

Mahoney: Service. Are they doing what they say they will do on the date they say? Is all the functionality as advertised?

TM: What service, either offered through the clearer or through a recommended vendor, is most important to an institutional broker?

Mahoney: From a trading point of view, it’s going to be functions. Do they have the trading functions I want? How quickly do they react to new functions that I request? But on the flip side, from the compliance view, it is going to be important that they are up to date with things like OATS, Reg NMS, etc.

TM: But I expect most institutional firms are compliant with these regs?

Mahoney: Right. Two or three years ago, new regulation was the most important factor. Now it’s back to service, features and functions. How do they react to clients’ needs? When they pick up the phone, they want someone intelligent enough to answer their questions-and if not, they want someone to get back to them in a timely manner.

TM: So clearers must be very careful in recommending a vendor because, if the recommendation isn’t satisfactory, the correspondent is going to be angry with the clearer.

Mahoney: Yes, when the correspondent has a problem, he’ll look to the clearer first. When they go back to the clearer, they’ll tell them, “You didn’t do well by me, the vendor didn’t meet my expectations.”

TM: Thank you, Mr. Mahoney.