Megamergers Shake Up Correspondent-Clearing Space

First, it was the Bank of New York acquiring Pershing, now it's Fidelity Investments acquiring the Correspondent Services Corporation from UBS PaineWebber. These instances of acquisition may only involve four firms but those firms service millions of dollars in trades for hundreds of clients.

When it comes to Fidelity's acquisition of CSC, the integration plan is being overseen by Norman Malo, president of Fidelity's National Financial Unit. He says that acquisition in the correspondent-clearing space is being driven by a need to get as much volume on a provider's systems as possible. "With things like the Patriot Act coming down the pike, you need to put more business on your platform just to make it justifiable," he says.

Originally, correspondent-clearing firms acted solely as outsourced providers of clearance and settlement services to brokerage firms, but have continually expanded their offerings to everything from front-end-trading technology to risk-management and market-data services.

When combined, Fidelity's National Financial correspondent-clearing business will become the number five provider in the United States with around 300 clients, according to figures from Massachusetts-based research firm TowerGroup.

The integration plan calls for CSC's 150 clients to move onto Fidelity's proprietary back-end clearing platform. Along with the clients, Fidelity will bring on 114 CSC employees who will continue to support the CSC client base.

As for which front-end workstation will dominate, things become slightly more involved. Malo says that Fidelity will not continue to support the PaineWebber front end, which CSC clients have been using. Rather, he says, CSC clients will either be offered Fidelity's proprietary front end, called StreetScape, or a third-party-vendor front end that Fidelity is in the process of selecting.

Though he would not name the victor, Malo says that the finalists for the deal are Reuters and ILX. "I need to be able to offer a front end that is not any different across any of the firms I support," he says. "I need to have a security master, equity trading, fixed-income trading and mutual-funds capabilities."

Any new Fidelity clients, aside from the CSC base, will also be able to continue using their own front end.

"My back end will have to accept these three different types of front ends," says Malo, describing StreetScape, ILX/Reuters, and any new-client-utilized front end.

In terms of actually moving CSC's business onto the Fidelity back end, he says that should be a fairly routine matter. "If you think about it, we do this type of integration all the time," says Malo. "We take a client that is clearing through another firm and move their books and records electronically."

"Basically, a customer stops trading at the end of day on Friday, that weekend all the books and records are transferred to the new platform, all positions are settled out at the old provider, and the client starts trading on the new platform on Monday morning," says Malo.

Though moving to a new provider has little practical effect on the client regarding the back-end processing. Moving to a new front-end workstation always involves some adjustment period for the brokers, says Malo. "They have to go through an educational process so there is always the risk of losing someone," he says.

The idea of losing clients is certainly a consideration in any merger or acquisition. Joe Velli, senior executive vice president and head of the Bank of New York Securities Group, says that he is "optimistic" that BNY will retain "the vast majority" of its clients when moving them onto the newly acquired Pershing platform (targeted for the end of September). Some BNY clients, however, have significant concerns about becoming a small fish in a big pond. (See WS&T March 2003 "BNY Clients Apprehensive About Acquisition.")

Velli, however, says that no clients will be left behind, indicating that success depends on "quality hands-on service to large and small clients alike," along with strong front-end technology (all BNY clients will be moved onto Pershing's NetExchange Pro front-end workstation) and sufficient capital to weather the current economic storm.

Part of Fidelity's motivation in acquiring CSC, says Malo, is to bring a fuller, securities-focused offering to regional brokerage firms. Traditionally, he says, Fidelity's sales force did not target the same client base as CSC, focusing more on banks and insurance companies. "We wanted to expand our capability to support a regional brokerage firm, to take our front end and make sure it supports a very securities-oriented business," he says.

Expanding services is certainly the name of game in the correspondent-clearing space. To that end, Velli says he prefers the term "financial-services-outsourcing provider" to correspondent clearer because such firms do much more than the name would indicate. Much like any provider that attempts to separate itself from the pack, correspondent-clearing firms that started out solely clearing trades for retail-brokerage firms have now morphed into full-service partners, providing an array of technology and services.

Rob Hegarty, director of Securities and Investments with TowerGroup, says that correspondent-clearing firms differentiate themselves according to the value-added services they provide. He says features such as expertise in trade execution, technology, risk management, access to markets, quality of execution, and access to capital all help separate one service provider from another.

"As with any maturing industry, people try and differentiate themselves by providing more value-added services than the next guy," says Hegarty. "So you wind up with an arms race of technology, involving things like execution quality, risk management, capital infusion; all kinds of fun things."

But getting into the correspondent-clearing space is not cheap. The business requires massive technology investment that never significantly abates, as regulations like the USA Patriot Act and myriad other tweaks to the securities landscape mean expensive technology update. Therefore, volume is critical to justify maintenance of an expensive platform. One way to get volume in a hurry is by acquiring a competitor.

Hegarty says that there is a cause-and-effect relationship between the BNY/Pershing, Fidelity/CSC deals. "Fidelity has been looking to grow for quite a while and they saw a quicker route to do so through acquisition, but I think the Pershing deal forced Fidelity's hand to acquire someone," he says. Together, the two deals represent a significant acceleration of consolidation in the space, says Hegarty.

BNY's Velli adds that consolidation in the correspondent-clearing space is at the just getting ramped up, saying, "If another (acquisition) opportunity came along, we would take a look at it. I certainly think the consolidation is going to continue until you wind up with three or four noteworthy clearing agents."