The Indian stock broking industry has emerged from an extremely difficult 2.5 years during FY12–FY14. It was served a double whammy in the form of falling volumes as well as realisations. The Nifty and Sensex delivered negative returns during that time, while mid-caps were in worse shape. Nifty earnings growth slowed down to single digit levels, reaching a low of 3.4% y-o-y in FY13. While the frontline broking names reported a fall in profits ranging between 50% and 95%, the smaller players went into losses.

Poor market returns was the primary driver of the volume decline and to some extent the fall in brokerage rates. Cash volumes in the market were down over 30%. Negative market returns led to redemption by investors, leading to continuous selling by domestic institutions, though FIIs were net buyers in the market providing some support. Flight to safety leading to limited churn, a fall in speculative interest and drop in quality offering from primary market further contributed to the declinein volumes. While F&O volumes remained largely flat, a significant part of those started shifting to direct market access (DMA), limiting the role (and revenue) of brokers in executing orders.

We estimate average brokerage rates (institutional) were down over 30% during that time. While the fall in brokerage rates is keeping in line with global trends as markets mature and volumes grow, the decline that time around was too steep and ran against the trend. At some level it was triggered by increasing competition with brokers bidding it lower for blocks, baskets and divestment. However, the SEBI regulation capping brokerage rates that mutual funds can pay at 12basis points (-bp) was a huge blow, lowering the benchmark for other clients too, who promptly followed through. The shift to DMA/ALGO trades also meant that the effective brokerage pool shrank significantly, as rates for trades put through them plunged to as low as 4-bp to 6-bp.

Chart 1:Quarterly profits of broking outfits

Chart 2:Stock performance of broking companies



Chart 3: Market volume trend (incl. 12-mth mov avg.)

Chart 4: FII & DII flow annual (fiscal)

While the pick up in market volumes, following the optimism and reform orientation of the new government, has changed the outlook of the broking industry, challenges due to technology (DMA/ALGO trades) and the lower brokerage rates remain. Both these factors have pegged domestic players at a significant disadvantage to global players (like Citi, UBS and Credit Suisse).

DMA entails significant capex in terms of the best technology and algorithms, where global players are at a significant advantage over domestic players, given the ability to procure and offer the same services across markets, making it a lot more viable/profitable. In the downturn, this helped protect revenues of some large global players, since DMA quickly notched up a market share in excess of 35% from almost zero, which continues to sustain. For a domestic player, procurement at high costs to service just a single market makes it less profitable.

SEBI’s capping of the mutual fund brokerage rate too affects domestic brokerages more than the foreign firms, since domestic firms are more dependent on mutual funds than foreign players. Though proportions might vary, most domestic brokerages would have a revenue mix, which is skewed towards domestic mutual funds vis-à-vis foreign funds. Thus, the capping hurts the domestic firms’ revenue more than that of foreign firms.

While, these two structural challenges are likely to remain, the pickupin market volumes is a huge boost for the industry. Domestic brokerages have the ability to bring in new investment ideas, which are very valuable in a bull market. Their continuous engagement with the industry participants provides them with the outreach to research and highlight new investment ideas. This would have helped them bridgethe gap created by DMA and lower brokerage ratesto some extent, in the rally which started about 12 months ago.

India remains a very large growth market holding huge potential. To put this in perspective, the past three months’ average cash turnover of the two exchanges (BSE and NSE) was 5.7x of 4QFY03 and the corresponding F&O turnover was 100.6x. This is a clear indication of the potential, though as discussed earlier, the brokerage rates tend to fall as volumes rise. We believe the turnaround we saw in the past 12 months is indicative of the market potential, though evolving technology will continue to challenge the business and competition is likely to increase given the growth potential. The two factors that are likely to contribute to an explosive growth in equity volumes in India are:
1. The likely accelerated economic growth and structural changes such as GST that is likely to lead to a much higher corporate sector growth than GDP growth.
2. Given the demographics of the country, risk appetite is likely to increase, channelling more savings into equity, thus benefiting the domestic mutual fund industry and in turn the brokerages.


Varatharajan S

Varatharajan S is Head Research for IL&FS Broking Services Private Limited, based in Mumbai.



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