SIFMA's Asset Management Account Roundtable began yesterday in Boca Raton, Florida, and Crane Data's Peter Crane spoke and hosted a panel of brokerage sweep providers on money fund and FDIC-insured sweep product issues. The big news among the brokerage cash sector was that FDIC-insured sweep assets now total over $1 trillion, and that rates on sweep accounts are inching higher after almost a decade stuck at virtually zero. Crane Data's Brokerage Sweep Intelligence product shows the average rate on FDIC-insured sweep vehicles ticked up earlier this year, rising from 0.01%, where it had been stuck for years, to 0.02%. But several brokerages, including Schwab, Raymond James, and Fidelity, have increased rates on selected sweep tiers recently, and we expect more to follow in the coming weeks as the last of retail money funds lift off from zero. (Watch for more coverage of sweeps and the conference in coming days, and let us know if you'd like to see a copy of our most recent Brokerage Sweep Intelligence.) Below, we excerpt from a new paper from StoneCastle Cash Management, a recent entrant into the FDIC brokerage sweep market, entitled, "Single Provider FDIC Insured Sweep Platforms Leaving Investors Out, Revenue on the Table, and Pressuring Brokerages to Re-evaluate Enterprise Risk Policies."
The piece, subtitled, "Making the case for multi-provider FDIC insured sweep programs," tell us, "Since the introduction of the first FDIC insured sweep offering from Merrill Lynch in 2001, insured sweep platforms have become the de facto sweep choice for most brokerages and other financial intermediaries. And while FDIC insured sweep programs are not new to the market, the groundswell in their popularity has created some potential risks to brokerages and financial institutions that maintain a single sweep provider."
It explains, "This paper identifies and explores enterprise risk that brokerages and other financial intermediaries may be encountering regarding their FDIC sweep program and how a multi-provider solution can substantially mitigate these risks while realizing the full benefit of an insured sweep program for the firm, its advisors, and importantly, its clients."
StoneCastle explains, "There are many reasons for brokerages/financial intermediaries to consider a multi-provider FDIC insured cash sweep program. This paper addresses scenarios that larger broker-dealers and smaller intermediary firms managing large deposit bases through single-provider programs should consider regarding: Capacity constraints or sub-optimal bank rates - As cash flows into insured sweep programs, a single provider may be limited in delivering attractively priced capacity to support both current and new clients; Potential headline risk of a single provider; Increasing competition as a lever to maximize client value and firm-wide economics; and, Revenue left on the table with excess cash sweeping into - U.S. government funds ... and Single deposit accounts."
Their "Introduction" says, "Insured cash sweep programs represent the predominant default sweep option for brokerages and other financial institutions because they are easy to understand and better position a firm to attract all of their clients' cash. They also provide absolute safety and security with a fixed one dollar value, enable the sponsor brokerage firm to offer tiered/relationship pricing, and the potential to earn significantly greater revenue as compared to money fund sweep programs. Brokerages have identified and capitalized on these value points and have grown their programs accordingly. However many of these same brokerages are now identifying and experiencing pain points that have emerged as a direct result of this growth."
It continues, "When extended FDIC insured sweep programs first came to market more than a decade ago, (and not including proprietary bank programs affiliated with a broker-dealer), there were only a few third party providers and little in the way of program deposits. Since then, the number of providers has barely budged, yet deposits in insured sweep programs (proprietary and provider/administrator) have exploded to more than $1 trillion with the vast majority of brokerages offering some type of insured program."
StoneCastle explains, "The issue lies not in the efficacy of FDIC sweep programs in general, which have proven themselves as a smart alternative to money funds for many years. Rather, it lies in the inability of one provider, as the few players have grown in size, to adequately accommodate increasing investor demand, particularly for mid-sized or larger institutions.... As a matter of record, some large/national clearing firms/platforms have made available multiple insured sweep providers to their introducing broker-dealers and registered investment advisors for many years. The choice has enabled brokerages to diversify their risk, offer a broader array of products and services to best meet the needs of their clients, and deliver higher levels of FDIC insurance per tax ID."
They tell us, "Third party FDIC insured sweep providers allocate deposits into program banks that are willing to take funding for a negotiated fee. The important note here is that a large amount of deposit capacity at a good price is not limitless. It comes down to a provider's ability to source these banks and appropriately negotiate the funding deals that makes sense for the program. In fact, banks typically have a limit on the amount of deposits they are willing to take from any one broker-dealer (conduit). And beyond that, they typically have restrictions on how many deposits they will take from any one sweep provider purely from a risk management perspective."
The paper also says, "Open architecture, or offering more than one investment option for advisors and clients has proven to be a good thing over time. It enables both advisors and clients to decide what programs are best suited for the way they conduct business or invest. And at a firm level, it provides program checks and balances that create a sustainable value lever. Sole providers can get complacent, focus energy and resources on giving the best deals to new clients, and may lack the motivation to just plain try harder."
It continues, "Additionally, and regardless of the advertised FDIC limits of your sweep program, there is likely a subset of clients that maintain cash balances in excess of current program limits. These deposits are either going to be uninsured in a bank account (i.e. over the $250,000 limit) or in a money market mutual fund. A multi-provider platform can quickly find a home for these deposits, support client retention efforts, and obviate the need to maintain any money funds remaining on the platform, which can become a significant revenue drain issue in a rising rate environment. As the rate environment changes and moves higher than the fixed expense of money funds, brokerages are essentially capping what they can earn."
StoneCastle concludes, "Cash is the one asset class in which every client has exposure and is typically one of the largest revenue producers for most brokerages. At the macro level, the fundamental goal of providing high levels of FDIC insurance for investors is more or less the same from all program providers. How they each accomplish it however, varies widely. Given the enterprise value of cash, brokerages should gain a deeper understanding of the differences in programs, exploit complementary synergies, and identify potential or real headline risks of each company."
Finally, they write, "Brokerages need to be aware of the marked advances that have been made with sweep technology that are keeping pace or staying ahead of their evolving needs. Combining these advances with the ability to tailor it to a brokerage's specific business model is what creates a more inclusive client experience.... By utilizing a multi-provider approach, brokerages can potentially decrease enterprise level risk and better fulfill their obligations to more clients in providing them with the best possible product solutions. It will also help to maintain or elevate their cash sweep programs as a leading revenue source for their firms and do so with little to no disruption to their current business."
