New equity clearing facilities launching in the US to compete with the National Securities Clearing Corporation (NSCC) will have their work cut out to win over market participants, according to a new report from research firm Tabb Group.
The report, ‘Competition in US Clearing: Cost, Risk & Challenges’, says that while change to US equities clearing is inevitable, any new entrants will be “swimming upstream”.
NSCC, a subsidiary of the Depository Trust and Clearing Corporation, is the US’s only clearing provider for equities. But it could soon face competition, following exchange group Nasdaq OMX’s intention to transform the Boston Stock Exchange Clearing, which it acquired when it bought the Boston Stock Exchange, into a new US equities clearing provider. According to the report, further sources of competition could include other stock exchanges and foreign clearing entities entering the US market.
While acknowledging that competition could cut clearing costs and boost innovation, Robert Iati, Tabb’s global head of consulting and author of the report, said many market participants, particularly large investment banks, are reluctant to fix a system that they believe is not broken.
“The typical clearing and settlement executive at a large investment bankis culturally wed to the current structure because it is efficient and the workflow is entrenched, solid and simple,” Iati told theTRADEnews.com. “Going outside that workflow and cost structure strikes fear of the unknown into many people.”
In the study, Iati points out that equity clearing costs in the US are already the lowest in the world, and that annual clearing costs per side have fallen more than 40% a year over the past four years. He also argues that, despite complaints that clearing costs have not fallen fast enough, they have kept pace with commission reductions. Commissions have fallen at a rate of 18.6% per year since 2004, while clearing costs dropped by 16% over the same period. In addition, the ratio of clearing costs to commission rates has remained virtually unchanged at between 5% and 6% since 2004.
As a result of many market participants’ satisfaction with the existing system, any new competitors could find it tough to get a foothold in the US market. “You are probably not going to get Morgan Stanley, Goldman Sachs or any of the really big brokers,” said Iati. “Anything that challenges a well-established and frankly very efficient status quo will succeed only by targeting a particular niche of that market initially. You have got to find a group of users that has low switching costs, less cultural resistance to change and no membership to the NSCC.”
Second-tier brokers could provide new clearers with a suitable client base, according to Iati. “It is a critical mass business,” he said “Unless you can achieve critical mass, you are never going to make this work.”
Nevertheless, Iati predicted that exchanges may try to tempt firms away from the NSCC by offering extremely cheap or free clearing in the hope of attracting more order flow. He added that exchanges could also lure firms to their clearing services by offering users bigger rebates for posting liquidity on their order books.