End clients of brokers might feel the same come 1 October, the day when a 1 July circular issued by the Securities and Exchange Board of India (Sebi) for market infrastructure intermediaries (MIIs), such as stock exchanges, clearing corporations, and depositories, comes into effect.
This is because after 1 October, end clients of brokers, who are used to zero brokerage or low brokerage on delivery-based trading, and on intraday and futures and options (F&O) trading from their discount brokers, might have to start paying higher brokerage.
Globally, most new-age brokers generate a significant portion of their revenue by routing clients’ order flow to market makers such as stock exchanges, which in turn either give a small portion of the money they collect from the end clients of brokers to process their orders or give rebates.
Although they might look minuscule on a per-trade basis, these rebates, when aggregated over a large set of trades over a month or year, become a significant portion of these brokers’ revenue.
As per publicly available information, the BSE and the NSE charge a transaction fee of 0.00375% and 0.00322%, respectively, for equity intraday and delivery-based orders placed by brokers’ end clients. If the brokers generate a large volume of orders, then these exchanges share a portion of their revenue with the brokers as a slab-based rebate.
Apart from these rebates, these brokers collect these transaction charges daily from their end clients, but brokers pay aggregate charges to the members monthly. This provides the brokers with negative working capital or a floating fund to generate extra revenue through their treasury operation, wherein they park the money collected from end clients for exchange transaction charges to generate returns before they are required to pay the money to exchanges at the end of the month.
These sources of revenue give an incentive to new-age brokers to charge zero or low fees on trades.
Fairness vs equality
Sebi, as a securities market regulator, is mandated to ensure all market participants are provided fair and equal access to MIIs by creating a level playing field for all brokers, irrespective of the size of the business they bring to the MIIs.
When new-age brokers, on account of discounts offered on trades, corner a large chunk of the market share and, in turn, create what management guru Jim Collins calls the “Flywheel Effect”—where more end clients sign up due to discounts offered by new-age brokers, and then when they trade, it leads to more slab-based rebates and floating funds for the broker.
Based on these incentives, the brokers, in turn, keep the flywheel running by signing up more end clients and generating more revenue in turn.
Sebi, through its circular, is trying to put a spanner in the works of this flywheel effect by mandating that MII charges, which are to be recovered from the end client, should be true to label, i.e., if a certain MII charge is levied on the end client by members (stock brokers, depository participants, clearing members), it should be ensured by MIIs that the same amount is received by them.
Additionally, it mandates that MIIs should ensure the charge structure of the MII is uniform and equal for all its members, instead of slab-wise, viz., dependent on the volume or activity of the members.
To compensate for the loss of revenue due to the implementation, brokers might increase their brokerage or, alternatively, bear the loss and make up for the loss from other sources. Many new-age brokers are funded by venture capitalists and private equity and might choose to bear the loss to maintain their existing market share or grab it from competitors if they choose to raise brokerage.
It might be part of their strategy to take their competition to the cleaners, but only if they survive through the strategy to tell their tale another day. This would create a scenario where who blinks first would determine what the end clients see as an effect of this circular—higher brokerage fees or status quo.
These steps, although they might seem unfair to some end clients or affected parties, do pass the test of equality. Fairness might mean everyone gets what they need, whereas equality means that everyone would get the same thing.
As Kaitlan C. Farrior once said: “Equal is not fair, and fair is not equal. Equal is obtainable but fair is not.” In our view, SEBI’s circular is a step in the direction of ensuring both fairness and equality, but some would disagree, so to them, I would say let’s agree to disagree.
Abhishek Kumar is a registered investment advisor and founder of Sahaj Money
