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Understanding the Economics of Your Clearing Relationship

November 4, 2019


Marshall Levin

The race to zero commissions has placed a spotlight on a part of our business that has experienced dramatic change during the last 10 years.

In working with firms to help them better understand their business, we continue to find ticket charges identified as the critical expense in the clearing and custody relationship. In fact for firm reliant upon transaction business model business, execution and clearing charges represent less than 40% of a firm’s “Clearing” expense. These firms receive more monthly revenue from the various sharing and incentive arrangements with their clearing firm than they pay in monthly clearing charges. The real clearing expense is in technology fees, account servicing and managed investment support. B-D’s have had “zero commissions,” in terms of a firm’s ticket charges, for the past few years.

How Clearing firms generate revenues from their correspondents and the overall shift in the economics of clearing & custody over the last decade or so is not clearly understood. This knowledge gap can impact critical strategic decision making.

Dust off a copy of your Schedule A from a dozen years ago and you will see how ticket charges have dropped significantly while revenue-sharing and other incentives have grown. The fact is, just as 12b-1 and other trailing revenues have become the largest contributor to your firm’s brokerage platform revenues, the fees and income generated from the servicing of these assets under their custody provides the greatest proportion of Clearing & Custody revenue. Fee-based assets in their custody generate the same revenues.

Obviously, Clearing & Custody firms know this about their own business. Quite frankly, when you sit down to renegotiate your agreement, they have the information and sophistication to know your profitability to them as a customer far better than you do. Assets under custody is the critical revenue driver for both you and your custodian.

We are seeing a new wave of clearing and custody relationship models from both the pricing and revenue sharing perspectives. The focus of these models is retaining and growing assets under their custodial administration.

Some of the recent trends include:

  • Bundling of technology fees
  • Bundling or packaging of advisor workstation fees and services
  • Annual account support fees in place of different Schedule A fees including trading, account servicing and non-billable or re-billable shares
  • Deeper incentives for adoption of electronic document delivery and other digital services. These new models can be a win-win relationship if you understand how to exploit the new design to match your business and evolving strategy.