“There is no free lunch”
Confucius, the revered Chinese philosopher had opined when asked to summarize his teachings in one sentence. But it seems that the sage advice has been tweaked by brokers. One may not get free lunch, but investors can be sure of free trading and investing in Stocks, ETF and F&O.
Charles Schwab’s shrewd decision of offering his investors zero commission online trade caused a flurry back in US as it started a ‘trade war’ of sorts in the brokerage industry. Schwab who is recognized as the father of low-cost brokers engineered a masterstroke on rival brokers by announcing the zero-commission price forcing them to lower their rates to remain competitive in the market or to lose the customer base. But this American dream may not yet be realized by Schwab’s contemporary Indian counterparts. The traditional Indian brokers who mostly depend upon retail broking for revenue will have to close their shutters if zero commission is implemented in India. Indian brokers do not have many channels from where they can earn revenue and there is a high probability that the Indian brokerage industry may collapse.
Nithin Kamath, Founder, and CEO of discount brokerage firm Zerodha agree that the zero-commission model may completely disrupt the Indian brokerage industry. He reminisces that he even got threatening calls from brokers earlier in the day when Zerodha lowered its brokering prices way back in 2010. He believes that the zero-commission model will cause greater damage than the price disruption pioneered by Zerodha. According to Kamath, the basic philosophy behind starting Zerodha was to give India its first discount broker firm. Initially the firm focussed on day traders while following disruptive pricing model and in-house technology. This philosophy made the firm the largest in India in terms of active clients.
But what is the zero-price price model exactly?
Zero: The new Hero in Brokering -
A broker is a financial intermediary between buyers and sellers to facilitate a transaction and is rewarded in the form of commissions or fees that are charged once the transaction is completed. Now with the advent of zero-commission brokering in the States, the brokerage firms are trying to leverage this loss by trying to mint money through other sources such as getting paid by exchanges for larger quantities of order flow. But this is just the US context. However, the Indian brokers do not have the ease which their US contemporaries have when it comes to stock markets. Faced with numerous regulations and caps on trading Indian brokers will have a hard time trudging their growth vehicle along this road.
According to Tim Welsh, founder, and CEO of wealth management consulting firm Nexus Strategy based in California, USA, the writing was always clear on the wall. He quips, “We’re heading to zero in all forms and fashions, and this is another milestone.” However, India may be extremely far from adopting this model into their business. Unlike traditional brokerage firms which still charge a percentage of the trading amount as fees discount broking firms like Zerodha, Upstox and 5paisa which are the top three stockbrokers in the country do offer zero fees in the cash segment, intraday and F&O trades attract a fixed rate of Rs. 10-20. Most traditional brokerages still charge a percentage of the trading amount as a fee. A large chunk of revenues for Indian brokers come from the commissions earned by them.
Can Indian broker ‘Schwab Style’?
The answer to the above question would be an emphatic ‘No’ due to the following reasons –
Indian brokers have to send unused funds back to the client’s account denying them the chance to earn revenue. This quarterly settlement rule indirectly impacts brokerage revenues in contrast to US brokerage firms who earn millions of dollars on idle client float.
Brokerage firms typically earn a commission when the orders are placed on their trading platform which is again sent to the exchanges in real-time for matching and fulfillment which again hurts their chances to earn extra income by way of order flow. A particularly good example would be the California-based American financial company Robinhood which earns most of its revenue from its order flows.
Contrary to their US counterparts, Indian brokers cannot lend securities as they sit in the clients’ Demat accounts with their depositories. India has a fledgling security lending platform called the Stock Lending and Borrowing (SLB) where clients can participate directly and even know the exact lending fees being earned, but it does not have much active participation.
Indian capital markets also lack a large professional advisory ecosystem like in the US to help their clients survive volatility. A bigger challenge in this regard is to address the significant conflict of interest as financial advisors are also often a distributor of the product.
Abysmal growth in the number of active clients is a hurdle for the Indian broker who is looking to expand his base. Currently, the number of active investors in India is 8.9 million and unless this number skyrockets 4-5 times the current number, the brokers have to wait quite sometime before they go all guns blazing in the fee war.
Furthermore, there was a buzz in the market that SEBI had developed a Direct Market Access System (DMA) which allowed investors to bypass stockbrokers and trade directly on the exchanges. In reaction to this news, the shares of prominent brokers declined by almost 8%. However, Deven Choksey, group managing director, K R Choksey Investment Managers, and Nithin Kamath, Founder, and CEO of Zerodha played down the development which was making the rounds on social media. They viewed it as an old buzz and believed that people will still turn to brokers for their superior technology and ease of getting transactions done. Deven Choksey opined that brokers ‘traditional roles will expand into something more multifunctional and deemed the DMA to be unsuitable for retail investors. The markets climbed back on this announcement.
There are caps on the Indian broker’s margin funding in addition to many other restrictions. But this does not mean that the Indian brokers have hung up their boots. They have been trying to expand other revenue streams such as offering value-added services. This includes same-day cash in bank accounts, a refund of the advanced brokerage on special turnovers, distribution of financial products, and wealth management services to HNIs and corporates. But the real question is – Will this be enough to counter the zero-commission fee wave which is going to hit the Indian brokerage industry. Because the change is going to come sooner or later, the industry has to brace for it to swim and not sink.
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