Self-clearing brokerages: A new trend?

What is a self-clearing broker?

A self-clearing broker is a brokerage firm that does not rely on a clearinghouse or separate clearing firm to buy, sell, and take custody of securities for their clients. Instead, a self-clearing broker settles the trades themselves and takes on all the duties of a clearing firm through their own back-office systems. This gives the firm the ability to keep everything in-house and eliminates the element of having to communicate with an outside third party. This leads to quicker and more effective completion of trades.

Why are firms making the push to become self-clearing?

The decision for a firm to transition to self-clearing or to outsource its operations elsewhere is influenced by various factors. Two significant considerations are gaining enhanced control and efficiency throughout the entire trading process and striving to boost profit margins by eliminating fees paid to clearing firms for their services, such as commission fees and market rebates.

One of the more prominent factors that influence a firm’s decision is the control over the trading process, which might not be attainable if they used an external third party. Having in-house trade clearing allows the firm to have start to finish control over any trades executed, which in the rare case of a trade execution error (such as an incorrect buy amount input) this allows the firm to quickly mitigate the issue since there is no need to go through the process of contacting the clearing firm to resolve the issue, saving time and effort. Without relying on an external third party providing these services, communication is streamlined, which allows the firm to provide quick and direct answers to their clients, or vice versa, for greater efficiency.

While these benefits may suggest that transitioning to self-clearing is the obvious choice, there are certain attributes a firm must possess to successfully transition, as self-clearing may not be the most logical choice for all brokers. While a broker will need sufficient capital and industry expertise to undergo this change, the most critical requirement for success is a highly competent operations team within the firm that is capable of effectively implementing the necessary back-office technologies, as well as conforming with industry regulations and standards that come with a clearing firm function. If a firm cannot do this, the push to self-clearing may not be the right move.

Control and risk factors

When a firm decides to become self-clearing, this introduces additional control and risk factors that should be considered when the firm’s annual audit is to be completed. The push to become self-clearing involves implementation of a competent back-office system capable of performing the function of a clearing firm. This will lead to an additional assessment performed by the auditor, as no SOC 1 report for the clearing firm would be available. This may lead to the testing of controls over significant areas of the back-office system that relate to materially significant financial statement line items and would result in additional costs.

When a firm makes the transition from introducing broker to self-clearing broker, it becomes subject to additional regulations, reporting requirements, and compliance standards that must be carefully considered. When a firm assumes a clearing function, it must evaluate specific risks associated with this role before making the transition. For example, clearing firms are responsible for the risk associated with the trades they make. These risks include operational, market and credit risks. To mitigate these risks, the clearing firm may be required to maintain collateral, such as securities or even cash, to manage any potential losses. This is why it is imperative that the firm looking to make this transition be well capitalized and have the industry knowledge to be prepared for such cases.

While there are benefits of becoming self-clearing, it may not be right for all firms. All factors should be considered as to this change's impact, both internally within the organization and external filing requirements. For additional insight as to potential impacts that should be considered an individual company, please feel free to reach out to Baker Tilly.