Should an introducing broker dealer become a clearing broker dealer? What you need to consider

By Shane Phelan, Baker Tilly

There are several factors that need to be considered should an Introducing Broker Dealer (IBD) want to become a Clearing Broker Dealer (CBD). An IBD, otherwise known as an introducing firm, will accept a client’s order for a buy or sell. However, it will have an arrangement with a clearing broker dealer, also known as a clearing firm, that will execute the order and maintain custody of a client’s securities and other assets.

Traditionally, an IBD is client-facing, and acts as an agent on behalf of individuals or entities seeking access to markets with a willing counterparty, a CBD. As a result of this relationship, an IBD has a much simpler business model, with revenue most commonly earned by commissions/rebates on trades executed for referred clients. They also have far less responsibility with respect to customer reporting obligations and data maintenance, as these are predominantly managed by the respective CBD.

While some responsibilities are consistent between both types of broker dealers, as CBDs handle the buy and sell orders as well as maintaining custody of client owned securities and other assets, they typically have a much more onerous back-office function, that can be quite labor intensive depending on its size and the types of securities in which it clears. These duties can include the following:

  • Clearing trades
  • Sending trade confirmations
  • Settlement and reporting compliance
  • Trade execution
  • Custody of customer funds and securities’
Costs of clearing functions

To facilitate the previous functions, a certain level of infrastructure needs to be in place. If an IBD was to perform these functions without any outsourcing, major areas to consider would be:

  • Large, qualified workforce
  • Specialized software and CRM systems
  • Additional regulatory compliance (SEC, FINRA and SOC compliance)
  • Working capital requirements

A significant portion of CBD’s operating expenses are personnel costs related to back-office functions and their associated compliance requisites. Technological development, cybersecurity and data privacy are at the forefront of both client and regulator interests, and a substantial investment is required to develop and implement. A high degree of on-going monitoring and a comprehensive understanding of the flow of data between internal and related external systems is necessary to continually adapt to these needs, conform with regulatory expectations and remain competitive. Additionally, as CBDs have custody over client assets, they must maintain high levels of net capital to be able to segregate the client funds and securities in their custody.