MODEL B CLEARING. HOW AN OLD CLEARING ARRANGEMENT CAN HELP NAVIGATE A CHANGING FUTURE

by Charles Lek, Managing Director of Lek Securities UK Limited

Firms look to outsource beyond counterparty risk

Samuel Lek

Samuel Lek

2013 marked the deadlines for many of the new directives enacted in response to the 2008 financial meltdown.  Regulatory topics ranging from the Alternative Investment Fund Managers Directive (AIFMD), European Market Infrastructure Regulation (EMIR), and Retail Distribution Review (RDR) to tax legislation such as Foreign Account Tax Compliance Act (FATCA) and the Financial Transaction Tax (FTT) have fundamentally changed the financial landscape forever. These changes will hopefully improve market efficiency and lead to greater transparency. However, with low volumes and sluggish growth throughout Europe and the Americas, many wealth managers are forced to reevaluate their business strategies.

The industry is changing rapidly, which requires firms to adopt more robust systems. FATCA and FTT require asset managers to integrate tax expertise not only in structuring portfolios, but also having the infrastructure in place to report to the appropriate agencies.

AIFMD, EMIR and RDR work to standardise how managers and clients interact, ranging from remunerations to client categorisation. These changes serve to improve transparency, but in doing so, also force asset managers to employ more comprehensive accounting systems; which can be costly – especially when it comes to advisory services.

Third party administrators have always played an important role; however in the wake of industry changes, the number of administrators has exploded whilst the number of clearing firms has remained relatively static. Many clearers still prefer a light touch approach, forcing wealth managers to look externally for tax and reporting expertise.

In response to industry changes, Lek Securities has witnessed an increase in demand for its Model B clearing services, especially from firms looking to outsource much of the administrative load. This type of clearing service was born out of the London Stock Exchange (LSE), and was first introduced to outsource counterparty risk, where an executing broker would give up a trade on the LSE to a clearing member for settlement.

Now however, with the increase cost in outsourcing, Model B has taken on a life of its own, allowing asset managers and family offices to utilise the infrastructure and particular competence of their clearer for accounting, regulatory reporting, and tax preparations, without giving up their brand recognition and personalised service. Everything from trading and portfolio management, to tax and regulatory reporting can be outsourced under one roof – effectively minimising the number of third parties and thus reducing the levels of both risk and cost.

Although counterparty risk is still to the forefront of people’s minds, portfolio managers need to demand more from their clearer than just a large balance sheet. In order to remain competitive, managers need to offer tailored portfolios for their individual clients, which in turn increases the demand for bespoke clearing solutions.

Wealth Mangers need more than trading authority to properly service clients, and are now seeking clearers who can satisfy their greater needs in order to build a successful portfolio and, in turn, can offer a competitive service to their clients. We are starting to see a trend of managers who are looking towards their clearing firm when it comes to outsourcing, instead of having to turn to a myriad of third party administrators. As we progress into the New Year, we expect this trend to continue, as more and more understand the benefits of one point of contact and, as a result, avoid the associated costs and paperwork.

2014 and beyond will certainly be an important period for the financial industry.  The implementation of new legislation, proposed revisions to the Client Asset Rules, and further developments under FATCA and RDR will continue to shape the marketplace. Clients and authorities are, understandably, demanding more from the industry, ranging from improvements in client money segregation, to further transparency in customer reporting. These new standards require wealth managers to have comprehensive systems and controls in place, which could mean involving more third parties and as such leading to a loss in brand recognition and client loyalty. By looking internally to their clearers under Model B, wealth managers can reduce the number of third parties, streamline costs and get back to doing what they do best, managing wealth. We look forward to supporting the industry in the United Kingdom, the Americas and Europe as we move forward into the new era.

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