The Future of Retail Brokerage

What will the retail brokerage market look like in the next three to five years?

Not an easy question to answer when we are living in an unprecedented time. Nevertheless, if you are the CEO or CTO of an independent retail brokerage firm, then it is a question you need to ask and explore with your most trusted advisors.

In an era where everything we knew as normal has changed, and margins are at an all-time low, it is a good opportunity to re-assess your operational infrastructure and consider its impact on your relationship with your clients and your ability to grow the company.

Most likely, you have been outsourcing critical operations to a well-known clearing firm. They eliminate a lot of headaches by clearing trades, generating statements for clients, managing regulatory requirements, and handling your investor relations activities. In exchange for a variety of fees that are passed to your clients, these firms give you assurance that operations will be relatively smooth, and transactions will settle with minimal errors.

This was a good idea when you were the new broker on the block, but does the value outweigh the long-term explicit and hidden costs of your clearing firm relationship?

FOMO: Fear of Missing Opportunities (for Client Growth)

• What is the impact of the transaction-based variable clearing fees on the virtual wallets of your clients and your own bottom line?
• How often do you receive complaints from clients for significant fees charged for voluntary corporate actions such as when a customer elects to accept a tender offer related to shares they own? Your clients may have become accustomed to fees incurred when they trade but are probably not unpleasantly surprised with fees incurred for tender offers or other non-trading events.
• Is the cumulative effect of these fees a deterrent for current or potential clients when they compare your services to firms that are self-clearing?

FOLC: Fear of Losing Control

• How satisfied are you with the style and speed of the periodic statements and tax reporting forms for your clients? Does your clearing firm give you any  flexibility regarding the format of these reports?
• Are you concerned that your competitors who use the same clearing firm deliver the exact same format for their clients?
• Have your clients been griping to you that these outsourced statements are confusing and look like something from the 1980s?

While there is some nostalgia for the cultural artifacts of previous eras, the emotional longing for the past does not extend to brokerage statement formats. You have been bringing your clients into the future with your online brand, but the brand may be diminished by these old-fashioned reports that are out of your control and dragging your clients backwards.

The Cost of Dependency

Are there other ways in which your clearing firm is holding you back from providing the ideal experience for your clients? For example:

  • How often has your client service department been handicapped by your clearing firm when researching the occasional failed trade or mismatch between confirmation details and settlement details? The 21st century client has an expectation of immediate satisfaction and has little patience for delays in resolutions of clearing and reporting problems.
  • How much of a dependency do you have on your clearing firm with regard to your plans for expansion? Do you find that your clearing firm is always the bottleneck on the critical path for adding new categories of trading?

Defending the Brand

In most areas of your service, you have been giving your clients what they want. A modern approach to investing: Intuitive tools on websites and phones that are as easy to learn as an ATM, and a growing set of money management functions and investment choices in stocks, bonds, forex, futures and other assets. These features have enabled you to get some share of the retail market, but are you bumping up against a resistance level in your growth that has nothing to do with the quality and uniqueness of your online offering?

To what extent is your growth impeded by dependency on another company to handle your operations using 30-year-old technology and statements that are laden with extraordinary fees? Are you ready to remove this yoke and prepare your firm for its next phase of maturity by internalizing previously outsourced operations? If the answer is yes, then you can build a future for your firm in which you:

  1. Gain a deeper understanding of the complete clearing and custody role
  2. Protect your brand for the entire breadth of your operation
  3. Provide better transparency for your clients when a clearing issue arises
  4. Govern your own transactional and event-based costs
  5. Develop new product offerings without needing to coordinate with unwieldy third parties

You have seen at least one of your competitors make this shift, allowing them to distinguish themselves from other independent brokers, as they recoup money previously paid to clearing firms. Are you ready to take that step?

First Things First

The decision to become self-clearing requires a significant investment in the right types of people and technology, which can be offset if you achieve a significant inflection in trading volume. Therefore, the costs and potential benefits should be carefully weighed against each other. 

The first step is expanding your team with people who are experts in regulatory compliance and clearing operations. You can probably find people with this expertise at large banks or brokerage firms and are likely to find several who would be eager to apply their expertise in a fast-moving innovative company like yours.

You need people who have a deep understanding of the reporting requirements from FINRA, as well as an understanding of market infrastructure firms such as the DTCC and OCC. With these people in-house, you will be better prepared to conduct a cost-benefit analysis and determine if and when the move to self-clearing is the right step for your company. If it’s a go, then your next step may be to evaluate whether you want to buy your own clearing technology, rent it from a specialized provider, or build your own – which would enable you to have the maximum amount of control.

If you chose to build your own, then you need to lead a transition for your current technology team members. These innovators who have built your state-of-the-art applications would need to become students of the more mundane areas of clearing, reporting, and statement generation. You can combine their innovation capabilities with the experience of your new operations and compliance experts to create a world-class infrastructure that will outshine your competitors.

As you take a fresh look at all the functions that your clearing firm provides, you might ask which of those do we think we can do more efficiently, cheaper and faster, leading to more volume and overall profits. Then, consider, are any roles worthy of moving in-house. For example, the role of shareholder communications is a specialty that requires an additional level of expertise and physical operations. At Mediant, our mission is to make our technology easy to integrate with and carry your branding, while providing multi-channel communications solutions including hardcopy distribution that would be difficult to replicate internally and justify from an ROI standpoint.

These are not easy decisions that can be made in a day or even a quarter. However, 2020 is a good year to begin this thought process with an initial analysis and then determine your vision for a future in which you have greater control over your own destiny.

For more information, contact us.