The sudden
wave of commission-free trade offers announced this week by some of the country's largest discount brokerages is shining a
fresh spotlight on where the fees paid by consumers ultimately end up in the elaborate financial services industry supply chain.
In particular, the
potential reduction in revenues from trading commissions has restarted conversations about how registered investment advisers pay for the products and services provided by their custodians.
"The phenomenon of reduced fees really hasn't touched the investment adviser yet, but their demands and needs for tech solutions and all the things to serve their clients have actually increased," said Ben Harrison, head of business development and relationship management with Advisor Solutions at BNY Mellon Pershing.
"We're definitely at a place now where we need to come together as an industry and think about a model that makes more sense in terms of paying for services that you value and meet the needs of your investors in your business, rather than having products that you use subsidize the revenue stream for the custodian," Mr. Harrison said. "We haven't figured out the optimal way to do this yet, but this is something we're talking to advisers about."
While Pershing is one of the nation's largest custodians, it is uniquely buffered from the zero-commission trend in that it doesn't operate a direct-to-consumer discount brokerage. But that doesn't shelter Pershing or any other custodian from the reality of fee compression coupled with the increasing transparency around fees.
"The pressure from all of this will bleed into the advisory world because transparency is on the rise," said Bill Capuzzi, chief executive of Apex Clearing.
Mr. Capuzzi sees increased fee transparency as the biggest threat to the current "freemium model, where advisers get free [custodian] services as long as they pass certain hurdles."
For example, he explained, an adviser with large cash balances in client accounts will get preferential treatment from custodians that can earn money off that cash.
Increased transparency, Mr. Capuzzi said, endangers the business model in which advisers are riding for free on custodian platforms that are earning money off client assets while at the same time charging those same clients an advisory fee.
"That will remain in place until the end consumers are pressing advisers and want to unpack and understand the ways in which they are charged," he said. "This won't happen in the next year, but something like this week's [zero-commission announcements] will make end consumers more aware of what they're being charged for and why."
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Michael Kitces, director of wealth management at Pinnacle Advisory Group, has been a
vocal proponent of a cleaner custodial-fee model. He thinks the industry is headed toward RIAs eventually paying custodians a small asset-based fee.
"Ultimately my expectation is that we're still heading in the direction of a basis-point custody fee, but I don't know that Schwab's announcement necessarily changes that much, at least pertaining to Schwab itself," Mr. Kitces said. "Trading fees were already a minuscule portion of their revenue."
Mr. Kitces added that custodians like TD Ameritrade, which relied more heavily on commission revenue, "will have more pressure to make up that revenue somewhere."
TD Ameritrade Holding Corp. responded to a request for comment with the following statement: "We're always taking a close look at our products and services, as well as how we deliver them, to ensure they meet the wants and needs of our clients. We're in constant contact with our clients, who help guide our business decisions so we can get better at what we do.
"Ultimately, our goal is to ensure we continue to offer the most compelling client experience and value in the marketplace," the statement continued. "With regard to your query on potential pricing changes, though, we have nothing new to report."
Not everyone in the financial planning community is shaking in their shoes about the concept that more direct payments for custodian services are coming down the pike.
"It is highly unlikely that custodians would move to charging advisers fees as they remain the gateway to the end user," said James Gambaccini, managing partner at Acorn Financial Services.
Dennis Nolte, vice president of Seacoast Investment Services, thinks changes are coming to fee arrangements, but "it's a couple years away."
"Advice is going to be paramount, and commissions are going the way of India, Brazil and Australia, where it's all about fees," Mr. Nolte said. "It'll be interesting to see if the custodians can make up lower-margin business in volume."
At Fidelity Investments, seen by many as the next likely candidate to announce free brokerage trades, there has been considerable research into the
"custody value stack."
"We've heard from a number of the advisers we work with over the past few days asking about how custodians are going to continue to invest in the business despite the loss in commission revenue. That's something that we all need to think about and it's getting lost in the headlines,"
David Canter, head of the RIA segment at Fidelity Clearing & Custody Solutions, said in an emailed statement.
Mr. Canter went on to provide examples of the value Fidelity provides to advisers and their clients, including "industry-best order execution and price improvement, the industry's lowest index mutual fund expense ratios, an award-winning brokerage platform, extensive practice management and consulting services, and choice on our cash sweep offering."
"Our clients understand that it costs money to do that," Mr. Canter's statement continued. "So as the economics of the industry undergo dramatic shifts, we are committed to maintaining our current level of service and will continue to be transparent with our clients with respect to future pricing models."
