The cost-cutting needs of brokers are clashing with the continuity demands of a utility. That is how the debate is shaping up over a National Securities Clearing Corp. trade-compression plan pending before the Securities and Exchange Commission. Brokerage officials charge the plan is arcane and would hurt them.
“This would be a substantial cost for everybody,” says Neil Fitzpatrick, head of retail executions at Chicago’s Citadel Investment Group, which aggregates high volumes of orders to execute for brokerage customers.
Trade compression happens when a broker-dealer aggregates hundreds and even thousands of orders to reduce clearing and settlement transactions. This is a critical cost-saving practice, say brokerage officials who are fighting the NSCC move. However, an NSCC spokesman says its trade-compression plan is vital. “We think this would be very good for the trading industry,” he says.
The NSCC trade-compression plan was initially filed in March 2006 along with proposed fee changes. The changes describe the vast number of uncompressed orders that would have to be processed. The large number is required to ensure that the NSCC plan remains neutral. NSCC is a subsidiary of the Depository Trust & Clearing Corp., which acts as a central settlement utility for equity trades.
In the filing, NSCC officials argued that the plan would reduce operational and systemic risk. And they argue today that risk results “from trade data not being submitted [in] real time.” Firms, NSCC officials add, sometimes “delay trade submission so as to pre-net their trade data.” This reduces clearance fees. However, NSCC officials also contend that their plan would give most brokers a break on fees.
The NSCC trade-compression changes, if approved, would have different effects on different kinds of brokers. For example, even though the proposal would dramatically increase the number of trades sent to the NSCC, clearing and self-clearing firms submitting those trades for settlement would see only modest increases in settlement fees under the NSCC’s proposed fee schedule.
The same cannot be said, however, for introducing brokerages compressing trades before sending them to their clearing firms. They levy higher fees that are enforced by multiyear contracts.
Those dynamics raise several issues that industry players and SEC staff and commissioners hashed out during meetings in October. Then, the regulators said they were keen on analyzing the underpinnings of the NSCC’s proposal and its ramifications for the industry before deciding whether to approve it.
Sources say some subsequent discussions between the parties have taken place. Still, any decisions on the issues, including the potentially prohibitive financial costs that could arise, should be made this year.
Len Amoruso, chief operating officer of Knight Capital Group, unofficially leads the group of 12 or so broker-dealers that participated in the October meetings. He notes that the combination of Regulation National Market System and new technology is continuing to squeeze brokerages’ margins and shrink order sizes. These factors mean compression is key in cutting costs.
For example, ECNs are highly efficient operations that have dramatically driven down overall trading costs. They are broker-dealers that tend to compress huge volumes of trades before sending them to their third-party clearing firms. Market center competition has squeezed their margins down to a fraction of a cent per trade. That’s a challenge faced by many in the electronic trading.
When we’re talking about businesses where margins are measured in basis points, anything done to increase costs could severely impact their ability to continue in that business,” Amoruso says.
Clearing contracts can be changed to adapt to a compressionless market. Still, some argue that a regulatory rule prompting cumbersome changes in commercial contracts is too intrusive. Eliminating the tool would require hundreds of clearing contracts to be renegotiated. Systems capacity would have to be re-evaluated to determine whether clearers can handle more volume.
Los Angeles-based Wedbush Morgan Securities and others filing comments have argued that the NSCC drastically underestimates the volume of trades being compressed.
Industry participants contacted by Traders Magazine heaped praise on the SEC for diligently analyzing the issue. Nevertheless, their tone could change if the regulator ends up siding with the NSCC. The self-regulatory organization has emphasized the importance of submitting individual trades in real time to reach the goal of same-day settlement. That improved settlement schedule would mitigate business continuity risk, NSCC officials believe.
Compressed trades are submitted at the end of the day, leaving broker-dealers vulnerable to disruptive or even catastrophic events during the trading day.
The brokerage industry argues that the industry’s new redundancy systems mitigate that risk. In addition, those firms say, the NSCC’s request for intraday trading data can be accomplished using existing infrastructure. These include drop copies of trades or even real-time submissions of trade data, without doing away with compression.
“The preference would certainly be to come forward with a solution that helps the NSCC to achieve its objectives and permits the industry to continue to realize the benefits and efficiencies related to compression,” Amoruso says.
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