What it means
In a split brokerage model the introducing broker finds and advises the client, while the carrying broker clears the trades and holds the account. The arrangement is set out in a clearing agreement, and the terms carrying broker and clearing broker are used almost interchangeably.
The split exists because clearing is expensive. Settlement systems, custody controls, regulatory capital and reporting all cost roughly the same whether a firm has 500 clients or 50,000, so small firms rent the function instead of building it.
Charges are usually a mix of a monthly minimum, a per-trade ticket fee and a share of the interest earned on client cash and margin lending. A firm's whole economics can turn on those ticket fees, because they are a direct cost against every commission it charges.
For the end client the important point is where the assets sit. Statements normally carry both names, the account is held at the carrying broker, and any investor protection scheme applies at that level rather than at the introducing firm.
Firms that handle the function in-house are called self-clearing. Some carrying brokers also hold positions in one combined omnibus account rather than account by account, which is cheaper to run but leaves the introducing firm with more record-keeping to do.
In practice
Real-world examples.
Example
A ten-person advisory firm signs a clearing agreement with a large carrying broker. Client shares are held in custody there, contract notes and quarterly statements go out through the carrying broker's systems, and the advisers spend their time on advice rather than on settlement queries. The arrangement costs the firm about 8% of its commission income.
Example
An online trading app launches with no clearing capability of its own and routes every order to a carrying broker, which also funds the margin lending behind customer positions. The app keeps the customer interface and the brand while the carrying broker carries the regulatory capital and the custody obligation.
Example
A small broker fails and its clients are relieved to learn that their cash and securities were held at the carrying broker throughout, not on the failed firm's own balance sheet. Transferring the accounts to a new introducing firm takes weeks rather than years because the assets never moved.
Formula
Calculation
Monthly clearing cost = (number of trades x ticket charge) + fixed platform fee
An introducing broker executes 4,000 trades a month. Its carrying broker charges $4.50 a ticket plus a fixed platform fee of $5,000 a month, so the clearing cost is (4,000 x 4.50) + 5,000 = 18,000 + 5,000 = $23,000. The firm charges its own clients $12 a trade, giving revenue of 4,000 x 12 = $48,000. Gross margin after clearing is 48,000 - 23,000 = $25,000, which is 25,000 / 48,000 = about 52% of revenue. If volumes halved to 2,000 trades the cost would be (2,000 x 4.50) + 5,000 = $14,000 against revenue of 2,000 x 12 = $24,000, and the margin would fall to 10,000 / 24,000 = about 42%.Case study
Seen in the real world.
Meridian Crest Securities is an illustrative, fictional brokerage with 14 advisers that spent two years weighing whether to clear its own trades. Its finance manager eventually settled the argument with numbers rather than principle.
Clearing in-house would have needed an extra $3,000,000 of regulatory capital, two settlement staff at a combined $240,000 a year and a settlement platform licence at $90,000 a year, so $330,000 a year of running cost. The carrying broker it already used cost $276,000 a year in total, made up of $216,000 of ticket charges and $60,000 of platform fees, and rebated part of the interest earned on client cash.
Because ticket charges rise with volume while the in-house costs are largely fixed, the in-house option only became cheaper once trading volume roughly doubled, and even then the tied-up capital counted against it. Meridian Crest stayed with its carrying broker and renegotiated the ticket charge instead, which is the conclusion most firms of that size reach.
Watch out
Common mistakes.
- Assuming the broker named at the top of the statement is the firm holding the assets, when the carrying broker further down the page is the actual custodian.
- Signing a clearing agreement on headline ticket pricing alone and missing the monthly minimum, the inactivity charges and the split of interest earned on client cash.
- Thinking a carrying broker also gives advice or selects investments, when its role is settlement, custody and reporting rather than recommendation.
Questions
People also ask.
Who is responsible if the introducing broker gives bad advice?
The introducing broker is, because advice is its function, while the carrying broker is answerable for settling and safekeeping, and clearing agreements usually spell out that division clearly.
Does using a carrying broker cost the client more?
Not usually, because building the same capability inside a small firm would cost far more, although the charges are ultimately recovered through commissions and account fees.
What is the difference between a carrying broker and a prime broker?
A prime broker bundles clearing and custody with financing, stock lending and consolidated reporting for hedge funds and other professional investors, while a carrying broker supplies the clearing and custody layer for retail-facing brokers.
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