Self-Clearing vs. Outsourced Clearing? Much More Than a Matter of Cost

Self-Clearing vs. Outsourced Clearing? Much More Than a Matter of Cost

Self-Clearing vs. Outsourced Clearing? Much More Than a Matter of Cost

Outsourcing clearing can help a broker reduce costs and enter new markets and asset classes more quickly. But not every firm can tolerate the loss of control over client relationships, and the cost savings aren’t always as advertised.
As financial services companies focus their attention on controlling costs, acquiring new business and leveraging their global presence, many are reviewing their existing operations and service-support infrastructures to enhance cost savings, efficiencies and service differentiation.

Traditionally, players that had a track record in a domestic market were used to self-clearing and had direct membership with central securities depositories (CSDs). But when a firm wants to become a multi-market player, it is faced with many challenges in terms of infrastructure, relationships and regulations.

As a result, many firms are considering business process outsourcing (BPO) or full outsourcing arrangements in order to enter new markets quickly. BPO helps alleviate the firm’s responsibility and resources required for settlement. A hybrid model, which offers elements of both self-clearing and outsourcing, also is becoming common. For example, a firm that self-clears in London may opt to outsource clearing for its New York operation.

Key Decision Factors

In the securities industry, participants with legacy in-house infrastructures, with all of the associated maintenance and staff costs, are considering BPO to help reduce dependency on those systems that can hold them back from entering new markets or asset classes. But making the choice between self-clearing, outsourced clearing and settlement, or a hybrid model in the securities markets is not a simple cost decision.

Self-clearing incurs relatively high fixed costs in terms of memberships, capital for collateral, staff, management time and compliance; while outsourcing tends to have low fixed costs but higher, transaction-driven variable costs. With volumes on the decline, variable costs can be more attractive, while a fixed cost structure is better in times when high volumes are expected. Currently, the industry is seeing a slightly stronger level of confidence in the markets; two years ago, the focus was on stability, whereas now firms are willing to review changes to their offerings that would emphasize innovation.

For small- to medium-size retail brokers in the U.S., where the market is well developed, outsourced clearing makes sense in terms of both economics and client service. A retail firm can make significant gains by aligning itself with a large clearing broker that exudes strength and confidence to end clients.

Conversely, large institutional firms face greater complexity in the decision to self-clear or outsource. For institutional firms, client service in the settlement process starts to become a differentiator, and product details become more critical, particularly for firms trying to offer a combination of more sophisticated, detailed products. This level of client service can be difficult to control if the firm is working with an outsourced clearer and even more challenging on an international scale.

The Middle-Office Question

Meanwhile, though a lot of the settlement processes reside in the back office, a number of BPO providers are looking to extend their reach up the customer value chain and into the middle office. This would involve maintaining direct relationships with a customer’s clients through service level agreements (SLAs). However, many financial firms prefer to retain control of the client relationships and middle-office processes. Although there are many advantages on a strictly economic basis, there is a fear of loss of control, especially in the institutional space.

Outsourced settlement has a number of benefits in terms of greater agility to trade in new markets. But some firms considering BPO are concerned about the lack of control over the process, a lack of transparency, and the potential cost reductions they can realistically expect to achieve as a result.

Some organizations are finding that BPO is not really delivering the staff cost savings they were hoping for, because they still need to communicate with clients and monitor the process to keep a certain level of control. The perceived risks could be greatly reduced or even eliminated, however, if the firm was able to shift business from one supplier to another, and consolidate information for the end customer.

A transaction management tool could provide firms with the control they demand by keeping all of their data in one place, while maintaining the transparency and information with their outsourcing providers. A middle-office transaction management tool could show a broker all of its clients’ business across the markets in which they are active – for example, if a client has executed business in France with one clearing provider and business in Asia with another provider.

From the broker’s perspective, staying on top of reducing and controlling costs is paramount. But in the near term, outsourcing decisions also will be driven by new market opportunities and the need to acquire and retain customers by differentiating themselves from their peers.