industry — trading commissions havebeen on the decline for years — this finalpush to zero put the industry spotlightback on how retail brokers/custodiansreally make money today: harvestingcustomers’ cash and receiving paymentfor order flows.
In fact, some 60% of Schwab’s entirerevenues come from net interest incometoday; it was nearly $1.6 billion in thefirst quarter. Schwab trading revenue,which includes payments tied to orderflows, stood at almost $190 million inQ1’ 20.
Meanwhile, as these dynamics playedout, another devastating wrecking ballwas let loose on the industry from thecoronavirus pandemic. Governmentreaction was swift, with the FederalReserve immediately cutting rates tozero, severely dampening the abilityfor retail brokers/custodians to harvestclient cash.
THEIR NEXT ACT
What happens to custodial revenuesnow? Will there be enough flow in azero commission and zero interest rateenvironment to continue to supportindependent RIAs, particularly smallerfirms who don’t generate as much revenues as larger RIAs for custodians?
The answer seems to be that theymust pursue scale at all costs. This isexactly what has happened in the firsthalf of 2020.
Schwab is well along the way to digesting TD Ameritrade, along with the technology of now-defunct Motif Investing,which sold its accounts to Folio in April.Folio then was purchased by GoldmanSachs, and that occurred a few monthsafter Morgan Stanley jumped into thegame by buying E-Trade.
So much for a sleepy corner of thefinancial services industry!
As a result, it appears that scale is thenew black. But will scale be enough?
What will the service models and sup-
port levels actually be in a world of thou-
sands and thousands of smaller RIAs
smashed into a mega-custodian that can
no longer make money from historical
lifelines of trading commissions and cash
spreads? What will be their fate?
As the industry debates these loomingand lingering questions, the custodianconsolidation trend continues from anunexpected corner, as yet another independent custodian is taken off of theplaying board.
Fresh off its purchase of Joe Duran’shighly successful United Capital mega-RIA, Goldman Sachs threw a body-blowto its Wall Street rivals by stepping fullforce into the independent RIA space byacquiring Folio, an innovative, technolo-gy-driven custodian.
Goldman is now armed with all of thecomponents it needs to become a fullplayer in this space thanks to the powerful client experience front-end of UnitedCapital’s FinLife and Folio’s advancedcustodian technology.
But will independent RIAs, whosetraditional negative views of Wall Streetremain front and center, want to placetheir client’s assets with a firm calledthe “Great Vampire Squid” by journalistMatt Taibbi of Rolling Stone magazine?
Similarly, will independent RIAswant to place their client assets with thefirm viewed by some as the poster childfor much of what’s wrong with WallStreet, Morgan Stanley?
The answers are most certainly no, leaving RIAs with fewer and fewer options.
In fact, industry experts see threegreat waves of migrations of RIAs thatshould soon be taking flight.
The first wave is already upon us, assmaller firms react to the acquisitionheadlines and are not waiting aroundto be swept up into the larger entities. Many of these first-movers havedeparted for the greener fields of nonretail, RIA-focused custodians such asShareholders Service Group (SSG).
The second wave is tied to when some
uncertainties are resolved and the time-
frames of M&A activities become clearer.
The Justice Department, for example, just gave its tacit approval of theSchwabitrade deal. Among the thousands of RIAs with TD Ameritrade, ofcourse, not all are happy about thisdevelopment and thus should do something about it.
The third, and potentially largestwave of migration, will come once thedeals are closed and advisors finallyexperience what it is like to be workingunder their new custodian overlords. Ifpromises and pledges are not kept, manyRIAs — particularly smaller ones who,by economic necessity, will get bundledinto call centers and DIY websites — arepoised to put their money in motion asthey search for a new home.
The good news is that chaos eventually attracts order, and traditional custodians without a retail division are workingto adapt their larger RIA platforms toaccommodate smaller firms.
In addition, new integrated technology players are coming together to provide a low-cost, comprehensive suiteof technology and custodial servicestargeting these potentially underservedsmaller firms.
TAMPs and technology platformsalso have been rumored to want to jumpinto the custody waters, making surethat independent wealth managementstays independent.
Despite all this uncertainty, the onething we do know for sure is that thesleepy custodian landscape has changedfor good.
RIAs are learning just how strategically important they are to the vastecosystem that supports them. Lookfor more to come as the custodianchaos continues.
Timothy D. Welsh, CFP, is president, CEO andfounder of Nexus Strategy, LLC, a leading consulting firm to the wealth management industryand can be reached at email@example.com on Twitter @NexusStrategy.