Discount broking entities face difficult times with the market regulator directing stock exchanges to stop the practice of charging lower fees from brokers with higher trading volumes. Vivek Kumar M explains the ramifications of this order

l  What is discount broking?

DISCOUNT BROKING, AS the name suggests, allows investors to trade at a lower cost by reducing brokerage or charging flat fees, along with minimal or free demat account maintenance charges. This is possible because stock exchanges offer brokers discounts on fees based on their trading volume. In turn, brokers charge investors a lower fee, thus earning the monicker ‘discount broker’, and indirectly encouraging investors to trade more.
One of the biggest advantages offered by discount brokers is the simplified process of opening a demat account. They often require less paperwork and offer account setup within a day, provided all necessary documents are submitted accurately.
Typically, discount brokers are good for the ‘do-it-yourself’ kind of investors. These brokers have come into prominence since 2019-20 when millions of retail investors entered the stock market. In the past four years, discount broking firms such as Zerodha and Groww have surged ahead of traditional full-service broking firms. Often, they also provide additional services like research tools and educational services.

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l Why is the market regulator worried?

SINCE THE COVID times, the Indian retail investor has been aggressively investing in the stock market. That should be good news. But what worries the Securities and Exchange Board of India (Sebi) is the surge in retail investors’ participation in the futures and options (F&O) market. The trading volumes in the derivatives segment of the National Stock Exchange of India has at least more than doubled in each of the last three years.

The concern is, as Sebi found in one of its studies last year, that nine out of 10 individual investors typically end up losing money in the F&O market.

A few months ago, even finance minister Nirmala Sitharaman expressed concerns about the unchecked explosion of retail investors in the F&O segment. Sitharaman said that household savings moving into equities shows the trust in the market, and this should be protected.

l  What are Sebi’s new guidelines?

LAST WEEK, SEBI came out with a circular directing market infrastructure institutions such as stock exchanges, clearing corporations and depositories to levy uniform and equal charges on stock brokers irrespective of the volumes generated by them.

The order will come into effect from October 1.

While Sebi did not specify the risks to retail investors in the F&O segment as a reason for the move, market watchers believe this is one of the reasons. The regulator said the existing mechanism can result in a situation wherein the aggregated charges collected by the members from the end clients is higher than the end of month charges paid to the market infrastructure institutions due to slab benefit. This, it said, can result in an incorrect or misleading disclosure to the end client about the charges levied by exchanges and clearing corporations.

l  How has the industry reacted?

SHARES OF LISTED big brokerage firms saw sharp declines following the Sebi circular. Shares of Angel One, India’s biggest brokerage, dropped 9% on Tuesday, while that of other big brokers fell 3-7%.

Nithin Kamath, founder and CEO of Zerodha, said this will have a significant impact on the financials of all brokers. “All brokers may be forced to tweak their pricing models to adjust to the new reality in a few months,” he said in a note. Kamath went to on to say Zerodha will now likely have to let go of zero brokerage structure. Meaning, it may start charging brokerage fee for equity delivery instruments and even increase brokerage on derivative transactions.

Shripal Shah, MD and CEO of Kotak Securities, said if increases in brokerage rates exceed the savings from reduced exchange fees for clients, trading costs may rise and potentially impact trading volumes.

l  Is it enough to check the retail boom in F&O?

NOT LIKELY. MORE regulations could be coming from the market regulator, and possibly from the government as well. Sebi has formed a committee, which includes brokerage firms, asset management companies and other stakeholders to look into the recommendations for new norms on F&O trading.

The revised norms could include increasing the margin requirement, tightening the eligibility criteria and requiring net worth disclosure for investors.

Moreover, even the government may be looking at discouraging retail participation in the F&O segment through higher taxes. The government may move derivatives trading to ‘speculative income’ from the existing ‘business income’ head, or consider raising securities transaction tax in the upcoming Budget.