Berndale Securities, a wholly owned subsidiary of Merrill Lynch, is pacing the embryonic field of correspondent clearers in Australia. As the only provider of full-service, balance sheet clearing, Berndale has already signed eight firms as correspondents since its inception in mid-2001, and expects to add another five to seven firms in the next six months, according to Craig Mason, director of transaction services at Berndale.
New Berndale clients include midsized firms Burdett Buckeridge Young (BBY), 30-percent owned by New York City-based Jefferies and Co., Southern Cross Equities Ltd. and Lodge Partners.
But despite the push by Berndale, it's uncertain how quickly the outsourced clearing market will take hold, given several factors: a down economy that's making broker-dealers reluctant to enter into clearing contracts; low volumes that keep outsourcing rates high; broker-dealers' current focus on mergers and acquisitions; and the fact that the back office in Australia performs fewer functions than in other markets, undercutting the motivation to outsource.
In addition, as previously reported (Securities Industry News, June 10, 2002), the challenges of interfacing to Chess, Australia's sophisticated central clearing system, was one factor in the proposed clearing venture between ABN-AMRO and Swedish technology provider OM not proceeding. Likewise, Securiclear, a proposed joint venture between Macquarie Bank and JB Were using ADP Wilco's Gloss system, did not find traction.
Other big potential outsourcers--Citibank and Bank of New York--have stayed on the sidelines, waiting until the economics are more favorable. Both Citibank and BNY would theoretically leverage off their existing custody and global securities services and target the largest broker-dealers--such as UBS Warburg, J.P. Morgan, Macquarie and JB were--if they were to enter the market. (The top 10 broker-dealers account for around 75 percent of all equities traded on the Australian Stock Exchange.)
But Boyd Lees, an SVP at BNY, Australia, believes that market entry won't be viable until offshore flows increase. "There is not enough flow in the local market. We've done the numbers and worked out what it would cost us to clear a trade and charge the market, and based on that we'd need certain volumes to make it work," he said. "Picking up a name like Were or UBS Warburg would be great, but that's just the start," Lees said.
That said, BNY is actively courting large broker-dealers. "Our commitment to set up a correspondent clearing operation in Australia is still there," Lees adds. "The large broker-dealers we have spoken to all believe they don't want to be in the middle and back office to the extent that they are."
Citibank, for its part, is already one of the largest custody shops in Australia, said Michael Massingham, securities country manager for Australia and New Zealand at Citibank. "We have significant synergies in terms of our existing client base, the technology that we bring and the people on the ground. Correspondent clearing would be a bolt on to our existing local infrastructure."
So far, however, practical issues have prevented the business case from being adopted, Lees said. "Brokers are saying We don't want to be in [the clearing] business, but right now we don't have the time to dedicate to this project because the market is down, and we can't afford it.'"
But Berndale's Mason remains optimistic. "We're right on the edge of a substantial shift that will change the entire landscape," he said, noting that just 14 percent of the value of equities traded on the Australian Stock Exchange are outsourced to clearing specialists. Other Berndale correspondents include Merrill Lynch, international market-maker Susquehanna, and Hedge Fund Zurich Capital Markets. Mason expects near-term growth for Berndale to come from mid-tier institutional firms, which account for around 20 percent of the market. "Seventy-five percent of our new business will be wholesale; however, there could be some large retail firms that could change that balance fairly quickly."
The emphasis on institutional firms thus far is something of a twist for Berndale, which initially targeted retail firms, expecting that declining volumes would force midsized firms to outsource. However, Berndale quickly found that those firms preferred to rationalize the cost of their back-office operations through mergers. "The focus has been on cost, but a lot of them have been merging or changing their business models to deal with that, as opposed to outsourcing," said Mason.
Eventually, however, outsourcing will take center stage, he said. "As some of these merged firms right-size themselves, the outsourcing model will probably be more attractive for them over the next 12 months, and they can redeploy some of that fixed cost."
Maybe so, but the negative economics of outsourced clearing cut both ways. Alex Ihlenfeldt, general manager of the midsized retail firm Wilsons HTM, evaluated outsourcing in 2002 with consultant KPMG, but did not find the cost benefit compelling. "One of the issues is that running a back office in Brisbane proved substantially beneficial when compared to outsourcing in Sydney or Melbourne," he said.
Nevertheless, Ihlenfeldt added, "the need to move fixed costs into a variable-cost environment remains a desire of ours, irrespective of anything else." And he speculated that a decision by one mid-tier retail firm could start a trend. "It would install confidence in the concept in the Australian market in those segments where it doesn't exist and will continue to bring the cost down, making it a more attractive proposition," he said.
Mason concurs that larger volumes will bring pricing down and lure more firms to outsource clearing. "There will be significant rationalization in the clearing price over the next 12 months to two years," he said. "It will come down because of critical mass."
For broker-dealers who already do want to outsource, Berndale is proving a formidable competitor. The strength of Merrill's balance sheet, as well as lower processing costs, is currently driving wholesale firms to Berndale, said John McKenna, COO of BBY. BBY, had previously outsourced its settlement operations to Australian Clearing Services (ACS). BBY carried its own settlement risk until September 2002, when the firm outsourced its balance sheet to Berndale.
"It's a huge advantage to have a bigger balance sheet to work off and be able to tell your clients you don't have to worry about that," McKenna said.
Southern Cross, a midsized institutional broker-dealer, recently moved from ACS to Berndale, partly due to the sale of ACS by its former owner, St George WEL Ltd., (Australia's fifth largest bank), to ACS Holdings Pty Ltd.
"As the largest pure agency derivatives broker-dealer in the country, we take the view that what we offer clients is intellectual capital on trading ideas. Clearing is a commodity. We believe that over the next decade our market will move to largely outsourced clearing, as it has in the United States," said Southern Cross Managing Director Peter Gray.
ACS' new CEO, Anthony Blumberg, was unavailable for comment, but sources said the firm's new focus will be outsourced processing services, not clearing (i.e., they will not carry settlement obligations), reinforcing the importance of clearers having a robust balance sheet and an appetite for risk.
Elsewhere in the clearing universe is risk specialist Fortis Clearing, a wholly owned subsidiary of the Fortis Group, which focuses on the outsourced clearing of derivatives traded on both the Australian Stock Exchange (ASX) and the Sydney Futures Exchange (SFE), according to the firm's risk division head, Raj Kapur. "Our business is geared toward market-makers, but we also cater to fund managers, banks, proprietary trading houses and hedge funds," he said.
Kapur contends that Fortis will grow through product diversification and access to new markets. "We can expand our business through providing a wider variety of asset classes, such as fixed income, swaps, interest-rate products and foreign exchange, as well as opening new markets to our clients, such as Japan, Korea, Singapore and Hong Kong," he said.
Overall, the development of the outsourced clearing market is on track in Australia, since the introduction by the ASX in May 1999 of new business rules designed to provide specialization and flexibility for broker-dealers and clearing firms, according to Chris Hamilton, executive general manager of clearing and settlement at the ASX. There is a lot of agency settlement activity by broker-dealers at the low end of the market, he said, where around a dozen firms have outsourced back-office processing to firms like ACS--although volumes are small--so the concept of outsourcing has some acceptance.
However, Hamilton sounded a note of caution about the future of correspondent clearing in Australia. Cost, as a driver for self-clearers to outsource, is not as compelling as in other countries, he said, and a big reason for that is central clearing system Chess allows a lot of back-office work--such as dividend distribution and corporate actions processing--to be done by the registries through the central clearing system.
"The thing that people never quite get is that in the United States and other depository countries, the back office does a hell of a lot more work than it does here, and the drive to outsource is correspondingly greater in those markets," Hamilton said.
Copyright 2003 Thomson Media Inc. All Rights Reserved.
