Types of Broker-Dealer Businesses in Secutiries Markets

An introducing broker-dealer has a relationship with customers in which it makes recommendations to customers on how and what to trade, but let’s another firm handle the execution of the trades.

A firm that executes transactions for an introducing broker-dealer is sometimes called an executing broker-dealer. The introducing and executing broker-dealers split commissions/fees according to a written agreement.

An introducing broker-dealer more typically contracts with a carrying broker-dealer. The carrying broker-dealer acts as the introducing broker-dealers back office, handling customer assets and clearing transactions through a clearing broker-dealer.

FINRA requires the firms to execute a contract between the carrying firm and the introducing firm stipulating the terms of the agreement for the carrying firm to hold customer assets and execute trades on behalf of the introducing firm. Or, an introducing broker-dealer may work with a clearing or self-clearing broker-dealer directly.

The clearing broker-dealer also performs back-office functions for the introducing broker-dealer. As the name implies, they are members of the clearing agencies and clear trades for themselves and other firms.

A clearing member firm is a broker-dealer that also provides many functions of a retail bank. They hold customer assets, and receive dividends, interest payments, and deposits from customers. One of the main sources of revenue and profit for such firms is the interest they earn on customer cash versus the small rates paid to customers.

As you can imagine, clearing members have stricter financial requirements than broker-dealers who avoid handling customer assets.

We looked at clearing facilities/agencies, including the National Securities Clearing Corporation, and the related Depository Trust Company.

Clearing member firms are members of a clearing agency as well as various exchanges and other SROs. If a broker-dealer is not a clearing member, it must have an arrangement with a clearing member firm to clear and settle its trades. An introducing broker-dealer typically pays a clearing member a fee per-trade. Also, if the clearing member extends any margin loans to customers, the introducing broker-dealer pays interest on such loans.

The term prime brokerage refers to bundled services that clearing firms offer to active traders, such as hedge funds. Hedge funds require more leverage than a retail customer and the ability to borrow securities for short sales. A clearing prime broker, a full-service broker-dealer, provides such specialized services for highly capitalized, actively traded accounts.


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