Clearing volume should be down some 15 to 20 percent this year, says Brian Duggan, chief executive officer of Goldman Sachs Execution and Clearing Services. That will pose challenges to clearing firms, especially institutional firms that depend on clients who record huge amounts of business,
he says.
The challenge is this: How can institutional clearers, whose businesses are built for scale, prosper when trading volume is expected to decline? Still, Duggan concedes that his counterparts on the retail side might have bigger problems, owing to dirt-cheap money that will hurt their spread business for Reg T accounts.
Some clearers won’t be able to cope. Therefore, more consolidation is ahead for the clearing business this year, he predicts. In other words, it will be a rehash of what has been going in the clearing business for some time. He notes that over the years Goldman Sachs bought Spear, Leeds & Kellogg, as well as First Options of Chicago. These were firms that had themselves acquired dozens of broker-dealers.
Goldman Sachs has been going through its own identity change: In 2008 it transformed itself from an investment bank into a commercial bank. Goldman Sachs, both the bank and the clearing firm, has had to adapt to tough times, as have its some 500 correspondents. These institutional clients include hedge funds, market makers and institutional broker-dealers.
Yet even in these hard times, Duggan believes there are opportunities for institutional firms like his that specialize in listed business. The problems of the over-the-counter business could very well help his firm. Duggan recently discussed these issues with Gregory Bresiger for Clearing Quarterly and Directory (CQ&D).
CQ&D: What’s the top priority for your correspondents in these uncertain times?
Duggan: The number one need for clients, besides having access to a global consolidated platform, is the ability to finance positions for them. Everyone is getting less inclined to extend credit and has become more balance sheet focused. Credit is becoming much more scrutinized.
CQ&D: Clearing is becoming a much tougher business because more banks have run into problems and there are fewer places to find financing for your clients?
Duggan: Very much so.
CQ&D: Institutional clearing firms, which could see dramatic drops in the business, have to do more to help correspondents find financing today? They’re in a very different situation than clearing firms servicing the retail customer?
Duggan: Yes, that’s a fair assessment. Most retail clients are carrying credit balances. What they’re dealing with in the clearing space is the decline of interest income. That was the spread you would make on your credit interest. When interest rates are near zero, that’s a real challenge for the retail clearing firms since they have a line item on their P&L that is now zero.
CQ&D: Is there a minimum number of correspondents needed to survive in this environment?
Duggan: It depends on your target market; retail or institutional.
CQ&D: So for you, on the institutional side, it’s quality and not quantity of correspondents?
Duggan: Yes. Our 500 clients are in the market every day. We have a good business model for the size of our client list.
CQ&D: Is there any part of the clearing business in which you think there will be growth this year?
Duggan: Our focus on growth will be on increasing market share. For the first time in a long time we are expecting industry volume to be down 15 to 20 percent.
CQ&D: Who will be your target market to get you through a time when business is depressed?
Duggan: In addition to gaining market share, we will look for new products to be listed on exchanges like Credit Default Swaps.
CQ&D: You only clear listed products?
Duggan: Yes.
CQ&D: Can you give an example of why listed may make sense in this environment?
Duggan: They mitigate counterparty risk and credit as well as price transparency
CQ&D: So you believe you can benefit from the problems
of OTC?
Duggan: We would definitely benefit from OTC moving to more exchange trading activity.
CQ&D: On another issue, the industry utility, the Depository Trust & Clearing Corp. (DTCC), may be facing competition soon from Nasdaq. Would Goldman Sachs consider using Nasdaq instead of DTCC, which provides clearing and settlement services at cost?
Duggan: If what the Nasdaq offering was attractive to our clients, (broker-dealers, institutions and market makers), then we would have to
figure out how to interface with their product.
CQ&D: What would they have to do to get your business?
Duggan: Convince our clients of the benefits.
CQ&D: But would you have any concerns with the Nasdaq for profit clearing model vs. DTCC’s at-cost model?
Duggan: My main concern would be that it would add another expense layer to our operations.
CQ&D: That someone won’t be hurt who wants to use both Nasdaq and keep some business with the DTCC, right?
Duggan: There would have to be a compelling business case for our clients to straddle settlements across the two like products. The products would also need to be fungible.
CQ&D: So you have some questions about whether firms like yours could use Nasdaq part of the time and DTCC the rest of the time?
Duggan: Yes, especially in an environment in which everyone is incredibly cost-focused. Firms are trying to save money and reduce additional operational costs, but if there are economic reasons that would make it attractive to our clients, then we would go there.
CQ&D: Mr. Duggan, thank you for your time.
Duggan: You’re welcome.
