Low U.S. interest rates might be shrinking profit margins at clearing firms, but the biggest players in the industry are investing for the future. And the future is in global securities markets.
“The U.S. used to represent 70% to 80% of the world's equity market capitalization; now the situation is flip-flopped,” said Mark Haggerty, head of product for Fidelity Institutional. “To be diversified, it makes sense to invest internationally,” he added.
Despite all the talk of going global, U.S. investors are homebodies, industry consultant Stephen Winks said. U.S. retail investors and their financial advisers have the bulk of their investment portfolios parked in domestic stocks, bonds and investment funds. And what little exposure they do get to foreign markets is largely through exchange-traded funds and mutual funds that invest in overseas markets.
“International assets still represent significantly less than 10% of the average adviser's book,” Mr. Winks added.
Nevertheless, Mr. Haggerty said Fidelity is committed to building its international trading capabilities for all custody and clearing customers. In 2009, it rolled out a new version of its Streetscape platform for retail investors and registered investment advisers, giving them access to more international markets and the ability to trade in more currencies.
Last year, it also expanded the platform for its nearly 300 correspondent broker-dealers. While the biggest demand continues to be from institutional broker-dealers, the volume of transactions in individual international securities has doubled on the firm's platform since the enhancements were made in 2009, Mr. Haggerty said.
“Clients want exposure from a combination of products, including individual securities, mutual funds and ETFs,” he said. “Different customers want it in different capacities.” Fidelity, which offers access to securities trading in 46 countries and in 20 different currencies, “can now compete for business we couldn't win in the past,” Mr. Haggerty said.
Fidelity isn't alone in expanding its international platform. Clearing industry leader Pershing LLC has been beefing up its offering in global markets for years and now gives access to securities trading in 60 international markets.
"A MATTER OF SURVIVAL'
Frank LaSalla, a managing director overseeing global operations at Pershing, said the firm is competing as much with European and Asian clearing firms that are looking to expand out of smaller home markets as it is with domestic rivals.
“Going global is a matter of survival,” he said. “The biggest trend we've seen post-financial-crisis is multinational firms' continuing to expand outside their home markets.”
With the support of its parent, The Bank of New York Mellon Corp., the largest institutional clearing provider in the world, Pershing not only is giving its clients greater access to international markets but increasingly is serving as a partner for other institutions looking to expand their global capabilities.
“For a large European bank that might want to set up in Brazil, rather than invest in brick and mortar itself, they can partner with us,” Mr. LaSalla said. “In the heady days when there was more patience and more budget, more firms would do it themselves. Now they feel they can't manage it.”
With the volatile investment markets and an increased need to assess counterparty risks in foreign markets, as well as the cost of developing infrastructure to operate in different regulatory jurisdictions, bigger firms such as Fidelity and Pershing have the advantage.
“Size matters,” Mr. LaSalla said. “The cost of building out global capabilities is not cheap.”
Even large firms have to make strategic decisions about where it makes sense to build infrastructure and where to form partnerships with local firms. For example, Pershing chooses to use members of local exchanges in markets such as Greece and Thailand to execute business, rather than invest in those markets itself.
“The unevenness in global economies makes us have to be stricter about how we operate,” Mr. LaSalla said. He said his firm has the flexibility to deal with change as it occurs. “If Greece were to exit the eurozone next week and move back to the drachma, we have a plan in place to deal with it.”
For smaller, domestic-oriented clearing firms, expanding operations globally or managing partnerships across fast-changing markets is prohibitively expensive. While some might offer capabilities in foreign markets where they have expertise, most can't make the investment, given current business conditions.
“Some firms might have direct clearing capabilities in foreign markets, but the more likely scenario is that they would funnel business through a local subsidiary or enter a partnership with a global clearing provider,” said Gert Raeves, a research director at CEB TowerGroup LLC.
“Clearing and custody are incredibly low-margin businesses,” he said. “With transaction volumes down, it's difficult to imagine a lot of speculative investment in this capability now.”
Indeed, with volumes down and rates so low, most clearing firms are treading water and are unable to think about building foreign-market capabilities.
If and when retail investors and their financial advisers start looking abroad more for stocks and bonds, the competitive advantage will tilt further to the larger firms.
“We think this a long-term trend in the market and expect it will become an even greater advantage for us in the next to 10 to 15 years,” Mr. Haggerty said.
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