How clearing firms generate revenue

Clearing firms are complex businesses with many revenue streams. For example, Charles Schwab lists 23 different revenue lines on its 2023 10-K (p. 85/235), including:

• Cash and cash equivalents: Schwab sweeps uninvested client cash to partner banks and earns the difference between what the banks pay Schwab and what Schwab pays out to clients in the form of interest.
• Securities lending revenue: By lending clients’ securities to other firms, especially heavily shorted and hard-to-borrow stocks like GameStop, Schwab earns fees for lending as well as interest on collateral that the borrower provides.
• Commissions: Despite some trades being commission-free, Schwab still made $1.6 billion from trading commissions on securities like options and mutual funds in 2023.
• Receivables from brokerage clients: Schwab offers margin loans to clients and earns interest when clients borrow on margin.

While Schwab has 23 distinct lines of revenue, they’re all tightly linked to assets under custody. For example, more assets generally means more uninvested cash for earning interest, more securities to lend, more trading commissions, and more opportunities for margin loans. Because of this, clearing firms often express their revenue as a percentage of assets under custody, and it usually ranges from 0.2% to 1.0%.

This means we can boil down increasing revenue to two main ways:

1. Earning a larger percentage on existing assets under custody.
2. Increasing assets under custody.

Let’s dive into #2.

Increasing assets under custody

You might think increasing assets under custody is straightforward: just create a better clearing product with superior technology and service. Then market it to potential clients. However, even after you’ve done all this and the potential client is convinced they want to switch, they’re not yet a client. Instead, they’re at the very bottom of the funnel of your prospective customers, and there’s still a good chance that they end up not converting, whether these clients are retail customers, financial advisors, or introducing brokers.

The abandoned cart problem

Retail customers, financial advisors, and introducing brokers can all abandon their cart when deciding to switch clearing firms. While they do so in different ways and for different reasons, they all lead to significant revenue losses.

1. Retail Customers: Individuals like you and me may want to move assets from one brokerage to another. However, when faced with a daunting/confusing process with very little transparency, we might decide it’s not worth the effort, resulting in a lost conversion and less revenue.
2. Financial Advisors: A financial advisor usually serves about 100 clients. A firm of financial advisors may have anywhere from one to thousands of advisors. When a firm of financial advisors thinks about moving to a new clearing firm, they will usually test the transfer process with a few smaller accounts, often their own. If the process is not smooth enough, they won’t dare put their entire client base through it, leading to an even larger abandoned cart.
3. Introducing brokers: Brokerages that aren’t self-clearing are known as introducing brokers. These brokerages rely on clearing firms to handle account transfers, a common arrangement for new or smaller brokerages. For example, Webull is an introducing broker and uses Apex as their clearing firm. Robinhood started this way before becoming self-clearing in 2018, and Altruist also used this approach before transitioning to self-clearing last year. Introducing brokers may have 10,000, 100,000, or even 1,000,000+ accounts, and the costs associated with switching clearing firms can be prohibitively high. They usually employ a process called a tape-to-tape conversion, with costs ranging from hundreds of thousands to millions or even tens of millions of dollars. Additionally, it requires a significant lead time, typically between 6 to 12 months or even longer, along with substantial employee resources to organize the transfer. The employee time alone can add millions more in costs. Given these substantial switching costs, it’s very easy for an introducing broker to abandon their cart and not change clearing firms, even if they really dislike their current clearing firm.

Crunching the numbers

The potential for new revenue from improving conversion rates from prospect to client is significant. For every $10 billion brought onto a clearing firm, there’s likely billions of dollars that were so close but lost due to cumbersome onboarding. Improving this important conversion rate by just 10 percent would mean an additional $1 billion in assets under custody, translating to $3 million in recurring revenue at a 30 basis point rate. These numbers can be much higher for larger clearing firms. For example, Schwab brought on $306 billion in net new assets in 2023 and made 24 basis points on average client assets, so improving conversion rates by 10 percent would yield an extra $31 billion in net new assets and $73 million in recurring revenue for Schwab.

Building better customer account transfers

At GoldenBasis, we’re experts in making asset transfers seamless and efficient, helping clearing firms maximize their revenue. If you’re a clearing firm looking to increase your conversion rates from prospect to client, let’s talk. We’re here to help you succeed.