According to new research from TABB Group, “Competition in US Clearing: Cost, Risk & Challenges,” which examines the growing importance of clearance in the U.S. markets, its impact on processing costs and the changing paradigm that may lead to the emergence of a more competitive business, the U.S. market is facing competition in the clearing business for the first time in nearly 40 years since the National Securities Clearing Corporation (NSCC) was formed in the early 1970s. Any new competitor in the US clearing business will be swimming upstream to some extent, says Robert Iati, author of the report, facing the prospect of challenging a firmly entrenched incumbent in the NSCC.
“The potential competitors are a mix of horizontal and vertical models and ownership structures that includes existing utilities, exchanges, clearing entities or quite possibly a combination of two or all three.” European entities are also part of this group, “since they’re eyeing the clearing space as new fodder for their businesses,” says Iati, a TABB partner and global head of consulting.
As much as the US financial markets industry has reaped benefits from the single-entity industry utility model, because it has unified the process for all, says Iati, “the lack of a true competitor to NSCC (a central counterparty that provides centralized clearance, settlement and information services for virtually all broker-to-broker equity, corporate bond and municipal bond, exchange-traded funds and unit investment trust (UIT) trades in the U.S.), provides no valid comparison to the status quo.” There is no doubt that NSCC, a wholly owned subsidiary of The Depository Trust & Clearing Corporation (DTCC), has consistently reduced its unit price to clear trades, but as Iati points out, “we don’t really know if it is optimal. Can the costs go even lower?”
Supporting his point, he explains that equity-clearing costs are lower now in the U.S. markets than anywhere else in the world, and that over the past four years, average equity clearing costs per side have fallen more than 40% per year, while annual volume grew by 46%. There has also been little change in the proportion of total US equity trade costs represented by clearance in recent years. While commissions have fallen at a rate of 18.6% per year since 2004, over the same period clearing costs have been reduced by 16%. Further, the ratio of clearing costs to commission rate has remained virtually unchanged at between 5% and 6% since 2004, “although many institutions believe that clearing costs have not fallen fast enough, when compared with the change in revenues (as measured by commission rates), the cost of clearing has indeed kept pace.”
This leads TABB Group, says Iati, to believe that new competitors will have difficulty matching the value offered by NSCC in reducing counterparty risk. “The only way a new clearing entity will be able to minimize risk is if it cooperates with the NSCC and works in conjunction with its existing clearing framework. This is virtually unavoidable since all market players currently clear their equity trades through the NSCC, and share the overall industry risk equally with all other members.”
At the same time competition is about to happen in the clearing space, post-trade processing is being pushed into the spotlight because of the recent, dramatic changes on Wall Street and across the marketplace. “There’s no doubt that any alteration to the current infrastructure is to be viewed with a great deal of trepidation,” says Iati. “Since clearing is so closely linked to risk, and in particular counterparty risk, it is essential that whatever entity enters the space is capable of managing the interoperability that is required for the marketplace to continue to run efficiently and without serious incident.”
The 24-page research report with nine exhibits can be accessed by TABB Group Research Alliance clients and qualified media at https://www.tabbgroup.com/Login.aspx . To request an executive summary or to purchase the report, please visit http://www.tabbgroup.com or write to info@tabbgroup.com.