Increase coming in ‘introducing custodians’ for RIAs

The upstarts will focus on a particular niche of the marketplace they feel is underserved, such as advisers with foreign clients or advisers focused on a particular investment approach.

This is the final installment of a four-part series in which guest author Brad Wales, founder of Transition To RIA, makes four distinct predictions for the financial services industry and challenges readers to consider not just if but when they will prove accurate. Read parts one, two and three.

My fourth prediction is that there will be an increase in “introducing custodians” for registered investment advisers.

The concept of an “introducing broker-dealer” has been around for decades. These are broker-dealers who, by choice or necessity, don’t themselves also provide the underlying custody services needed to accommodate customer assets. Instead, these introducing firms rely on a “clearing” broker-dealer to provide the actual role of custody.

Some broker-dealers are in effect both introducing and clearing at the same time. Other broker-dealers, particularly those smaller in size, generally rely on a separate clearing broker-dealer.

There are a few examples of this same sort of arrangement occurring in the RIA custodial space. In each case, these firms have the direct relationship with the RIAs that clear through them. They provide the technology (if applicable), they provide the customer service and they provide the improved experience that their respective founders believed was lacking in the marketplace.

However, these firms are not the underlying custodian themselves. Just as with introducing broker-dealers, these “introducing custodians” outsource the actual act of custody to larger custodians whom, among other things, have more scale than they do and likewise can supply the needed resources at a lower cost.

So why would an RIA use one of these introducing custodians, when they could simply go directly to an underlying custodial option instead? Here are a few reasons:

Asset minimums: Depending on your assets under management, some custodial firms are not an option for you. While minimums vary from firm to firm, some custodians have asset minimums starting at $100 million-plus. If you’re an RIA that’s under this hurdle, that custodian is not an option for you Align yourself instead, though, with an introducing custodian (who clears through that larger custodian themselves), and you’re in the ball game.

Service: As the large traditional custodians continue to grow in size, there has been an increase in the prevalence of “tiering” of service levels. If you have assets under $X million, you have to contact a call center for assistance. A little farther up the tiering, perhaps you get a more refined group to call into, but still a group, nonetheless. Grow large enough, and you get a dedicated relationship manager. It’s not unheard of nowadays to hold hundreds of millions in assets with a particular custodian before a dedicated relationship manager is considered. With introducing custodians, though, you may get a full-service experience regardless of your asset size.

Technology: The topic of whether to use a technology stack provided by a custodian or third-party solutions instead is an entire discussion unto itself. Regardless of where you fall on that spectrum, technology is still a relevant consideration when reviewing custodial choices. There are some introducing custodians that in part stake their flag on providing a superior technology experience for the RIAs that use them.

My prediction is that we will see an increase in such introducing custodians. These upstarts will focus on a particular niche of the marketplace they feel is underserved by a direct-to-traditional custodial approach. Such niches could include advisers with foreign clients, advisers focused on a particular investment approach, such as passive, or smaller advisers still needing scale.

Such upstarts should be welcomed by the traditional “clearing” custodians. After all, the clearing custodian is essentially outsourcing most, if not all of the adviser- and client-facing experience to the introducing firm.

Takeaway: Will this prediction come true? If so, what timeline do you foresee for it?

Brad Wales is the founder of Transition To RIA, a consulting firm uniquely focused on helping established financial advisers understand everything there is to know about why and how to transition their practice to the RIA model.