Robinhood launches self-built custody and clearing service

Move is likely a step toward an IPO, but the company would not say if it plans to serve advisers

Oct 10, 2018 @ 3:00 pm

By Ryan W. Neal

Online brokerage Robinhood is launching its own custody and clearing system.

The move helps the fintech startup, best known for offering zero-fee trading via a mobile app, cut costs in the likely run-up to an initial public offering. It's also the next step in the company's goal to be a "full-service financial company." But Christine Hall, the product manager leading Clearing by Robinhood, wouldn't say whether Robinhood plans to offer custodial services to financial advisers.

Ms. Hall did say that Robinhood began building its own custody and clearing system two years ago, and she described the effort as "the single most complex regulatory and engineering challenge that we've undertaken." The company has formed the Robinhood Securities entity and secured approval from the Financial Industry Regulatory Authority Inc., Depository Trust & Clearing Corp. and the Options Clearing Corp.

Robinhood is following in the footsteps of discount brokerages like Charles Schwab and TD Ameritrade that leveraged retail brokerage platforms 30 years ago to offer custodial services to advisers and accelerate growth.

"The path to greatness for any broker-dealer online has always been through the independent adviser," said Tim Welsh, president of Nexus Strategy. "The most profitable thing to be is a custodian. They're going to have to hire salespeople and sell custody services to advisers."

Robinhood has raised $539 million to date and faces pressure from shareholders to become profitable. Without charging trading fees, the brokerage generates revenue with a premium service that allows for margin trades, with interest earned on cash balances and by routing order flows to third parties.

A spokesperson said Robinhood has "a desire to be a public company."

Robinhood previously used Apex custody and clearing, but Ms. Hall said the company knew early on that it would need to self-clear to handle the scale it envisioned.

"Before even launching, we had over a million people on the wait list," Ms. Hall told InvestmentNews.

The Robinhood app went live in March 2015 and now has 6 million client accounts.

In addition to cutting Robinhood's own costs by eliminating a third party, Ms. Hall said self-clearing will reduce fees (such as overdraft charges) even further for clients, allow for better customer service and let Robinhood move functions like client statements, tax documents and proxy voting in-house.

"We saw that there hasn't been a lot of innovation in this space for decades," she said.

Building a custodial system takes an enormous amount of time, so many brokerages rely on systems built in the 1970s.

"Because we are a technology company first, we wanted to go self-clearing and build a system from scratch," Ms. Hall said.

(More: Outdated tech could be the industry's greatest vulnerability — and greatest defense)

The company claims Clearing by Robinhood is the only clearing system that has been built from scratch using modern technology since Vanguard built its system in 2008.

Wealthfront left Apex in 2017 to use a self-built omnibus platform for banking and brokerage, but it does not hold assets in-house. Betterment self-custodies assets but uses Apex for clearing services.

Apex CEO Bill Capuzzi said Robinhood co-founders Vlad Tenev and Baiju Bhatt first approached his company in 2013.

(More: Apex will soon custody cryptocurrency assets)

"We were the only company that had the technology to enable Robinhood to create and scale their simple user experience. That's what we do. We help companies that want to democratize investing, whether they are startups that need to scale or mature companies that want to move quickly into digital wealth," Mr. Capuzzi said in a statement. He also wished Robinhood well in the future.

Although Apex lost both Wealthfront and Robinhood, Mr. Welsh said the firm is uniquely positioned to offer automated custody and clearing not just to digital startups, but directly to advisers as well.

Both Apex and Robinhood have the technology to make a play for next-generation advisers' assets, and it could be possible that they rival existing players. After all, Schwab and TD were newcomers to the adviser business 30 years ago, so Robinhood could be a household name in the future.

The challenge will be how the big firms will respond if Robinhood is successful. Just as large institutions watched the robo-adviser space before building their own, Mr. Welsh said all custodians are keeping an eye on Robinhood.

"They can watch innovation, and they can replicate it," he said. "They'll just say, 'Robinhood is a beta test. If you work, we will copy you and crush you.'"

(More: TD Ameritrade adds socially aware portfolios to retail robo adviser)

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