LPL Financial will shift to so-called free credits as its primary cash overflow vehicle to help insulate the firm from the impact of fluctuating bank deposit demand.

“Currently, when we have more cash than third-party banks are willing to take, we utilize money market overflow contracts for excess capacity,” LPL says in a Q1 2022 Investor Presentation published Tuesday on its website.

“By instead implementing sweep deposit overflow to a brokerage cash account (commonly known as “free credits”) and investing the cash in short-term [U.S.] Treasuries, we are able to generate economics superior to money market funds, which are capped at ~45 bps [basis points], in most rate environments,” LPL adds.

The move makes LPL "well-posiitoned to benefit from rising interest rates," according to the firm.

“Optimizing our returns, while providing a seamless experience to clients, utilizing free credits to capture sweep overflow could improve the annual gross profit by up to ~$30M [million] per rate hike,” LPL says in the investor presentation. The estimated profit is based on an assumption of a money market overflow balance of $14.5 billion, as of March 31, shifting to free credits.

The buildout of the operational and technological infrastructure for the free credits is underway, according to LPL, which plans to launch this sweep overflow shift to free credits by the end of the third quarter.

The use of free credits is new to LPL “but a very common capability in the industry,” chief financial officer Matt Audette said Tuesday at Morgan Stanley’s 2022 U.S. Financials, Payments and Commercial Real Estate Conference.

“The key is it’s on our balance sheet, so we’re not dependent on third-party banks to have space on their balance sheet for that. Our focus is in U.S. Treasuries, very short-term U.S. Treasuries, 90 days or less, little to no credit risk, little to no duration risk and therefore little to no capital required to do so,” he said.

The Securities and Exchange Commission’s Rule 15c3-3(e) requires a broker-dealer to maintain a reserve of funds or qualified securities in an account at a bank that is at least equal in value to the net cash owed to customers.

LPL may make changes to its cash sweep programs, according to an LPL disclosure on March 31. Specifically, the firm may use free credit balances “in the ordinary course of its business subject to the requirements of Rule 15c3-3,” the disclosure states. Doing so “generally generates revenue for LPL in the forms of interest and income,” which the firm “retains as additional compensation for its services to its clients,” according to the disclosure.

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