How are the new regulations going to impact the domestic brokerage industry? The fact is brokerages can now only lend as much as their own capital. They could pledge on unpledged securities to raise funds. All these restrictions that have now been imposed.
It is going to have a big impact on the traditional brokers. The new age modern ones have not really been doing margin funding as much. But the people who have been in the ecosystem for a long period of time, they have traditionally grown their business using margin funding and leveraging securities, etc. They will be impacted over the next few months. There are not too many big listed players in this space to track the financials.
Will the new norms impact traders as well and if so, how much incremental margins will they now need to provide? Also, how much less leverage will they be able to obtain because of that?
Traders will eventually get impacted. It all depends on how deep the balance sheet of the broker is. The traditional brokers will start cutting down on the leverage they offer to the customers because for them to offer the leverage, their balance sheet has to be of certain size. The traders eventually will get affected. It is not necessarily bad for the ecosystem. The lesser leverage is not really bad for the industry in the longer term. But near term, it will end up affecting the brokerage income and the margin funding income for a lot of the traditional players.
That would also impact trading volumes, especially in options markets where the leverage is much higher?
Not really because in options you have to put the premium that you used to purchase an option. That cannot be used through the margin funding route. There are two things here – one is margin funding for buying equity stocks which is what is going to get affected the most here. If I have Rs 1 lakh stocks until now, I could potentially buy Rs 4-5 lakh stocks with it and the remaining 3 or 4 lakhs would have been funded by the broker. That is going to stop. That kind of leverage will reduce significantly.
On the futures and options side, the broker could never fund the customer because that rule has been there right from the day futures and options were introduced. The margin has to come from the customer. So the future and option side would not get affected. This will essentially affect the equity delivery volumes in exchange.
How are the norms different from that in the US? Would the Indian brokerage business model be able to sustain zero fees with the new regulations coming into effect?
No like the block post that I had written, kind of went quite viral. The thing is if you want to go zero in terms of brokerage revenue, you need to have other ways to generate revenue as a business. In the new age, start-up ecosystem, you do not even need to generate revenues to have a business. You could just raise equity. So go out and raise money and say that you are growing the business and you will eventually make revenue in some form.
But you need to have some other ways of generating revenue. In the US, the brokers have a lot more different ways of generating revenues, whereas in India it is limited. Someone like us do not charge revenues on equity delivery, but we do charge Rs 20 a trade on futures and options and intraday trades. That is how we are able to generate revenue as a business and sustain. If you had to let go of everything and go to zero brokerage fee, there may not be any business left to do tomorrow. In the US you can generate revenues in multiple forms — right from payment to order flows.
Sebi has done a great job in kind of not allowing that to happen in India. When a customer places an order, a broker in the US can make money out of the order flow itself. There is the float income, which is interest earned out of money which is sitting ideal on client accounts. In India, we have a quarterly settlement rule. There is no such rule in the US where brokers generate a significant amount of revenue out of the float income and securities lending. In India, the securities are held by the customer whereas in the US it is actually held in the street name of the broker. Brokers can lend securities which belong to the customer and make money.
In India, you cannot do that and again this whole margin funding rule that has been put into place now limits how much a broker can actually generate out of funding. So, assuming that as a business, I have Rs 100 crore of my own capital, I can at the max generate say 10% on this — Rs 10 crore.
Earlier, with this Rs 100 crore, you could leverage up to say Rs 400-500 crore and generate a lot more income which is not possible today with these new norms.
How many additional customers or revenues will be needed to be added to offset the losses sustained as a result of the new regime?
In India, if everything went to zero, there is no other way to make money. You cannot really add more customers and generate revenue. Someone like us could let go brokerage on equity delivery because we generate so much more in terms of intraday and futures and options brokerage. But the big problem in India is that the markets are extremely shallow. Today, we have six to seven million unique investors in the country, people who have invested once a year in the full year.
For us and for the ecosystem to grow, this number has to become a lot bigger. India needs at least 20 to 25 million actively participating Indians in the capital markets to have like four or five Zerodha kind of players where we charge extremely low fees and still manage to survive. I am making some money as a business as well. So, the market has to grow three-four times in size. But the problem is that India is missing an advisory ecosystem. Most people who end up trading and investing in the markets, do not really have a background of trading and investing. So they end up making mistakes. There are people who sell tips and buy above this and sell below this information. But those really do not help grow the ecosystem.
A professional advisory ecosystem is missing in India and I think regulators are doing a great job in pushing the RIA business but the need of the hour is to find ways for RIA to generate revenue as well because today for an investment advisor to charge his fees to the customer, as you go back to the customer every month and bill him. It is extremely tough.
In the US, the beautiful thing is that a broker can actually collect advisory fees on behalf of an advisor and pay the advisor from the customer. India needs something like that which allows advisors to easily bill and charge customers some money and then that money kind of goes through a non-friction route from the broker to the advisor and not really from the customer to the advisor.
The frequency of technology glitches has increased. There has been a lot of anguish among customers. Do they have any business continuity planning servers that is automated that can help assuage some of these concerns or are there any alternate solution to work with?
Today brokerages are actually more technology companies because most of the trading today is happening online and in any technology business, downtimes too happen. Now in a brokerage business, we rely on multiple factors to remain up all the time. So, every broker has a continuity plan but the ratio is most of our business is concentrated in 6 to 6.5 hours and if something were to go down, just to bring something back up, it can take like 15-20 minutes, 30 minutes and in the trading business, you cannot afford to be down 15, 20, 30 minutes.
The problem is that these technical glitches happen a little too often. Has there been an enquiry by the regulator because one was picking up some chatter around this on the system glitches that you have been facing?
It is just not us. It has happened at multiple levels. When it happens at Zerodha, you know as we are big today in terms of the number of people.
In an enquiry by the regulator you are agreeing to that?
We proactively go out and explain. We put out a blog post before anyone even asked what was the reason and what we have done to fix it? That is what regulators want to know. I have heard the news about having some penalties going forward, but nothing that we have been told directly.