[Jainam Shah and Siddhanth Singhi are 3rd year students at the Gujarat National Law University.]
Introduction
In a notable regulatory development, the Securities Exchange Board of India (SEBI) has released a circular stipulating mandatory imposition of "True to Label" charges by market infrastructure institutions (‘MIIs’), encompassing stock brokers, depository participants, and clearing corporations. This initiative seeks to establish uniform fees across market participants, superseding the prevailing volume-based slab-wise charges.
This blog sheds light on the directive, which is poised to have significant implications for various market participants, particularly brokers and investors. The latest circular titled “Charges levied by Market Infrastructure Institutions – True to Label”, which comes into effect from 1st October 2024, mandates brokers to ensure that any MII charges levied by them on their investors should be equal to what they deposit with MII. This circular, as said by SEBI, aims to make investing in the stock market, more informed and transparent. This post delves into the nuances of SEBI's landmark decision that will significantly impact participants across the market. By issuing such a directive, SEBI underscores its commitment to regulating the equity and derivatives market, as evidenced by the recent decisions of the regulatory body.
Financial Impact on Brokers
Historically, brokers have charged transaction fees on a ‘per transaction’ or ‘daily’ basis model, while the MIIs (Stock Exchanges) have levied transaction fees on their overall monthly turnover. Exchanges currently charge slab-wise fees from brokers. The higher the volume, the lower the fees, a broker has to pay. On the other hand, brokers take the fees mentioned in the highest slab provided by the exchanges. Hence, upon higher volume, brokers could earn from paying less to the exchanges. This difference between the transaction charges levied and paid is known as rebates, which is a monthly income stream for brokers and may contribute approximately 8-10% of the stock brokers’ revenue.
Here is an illustration of SAMCO Securities, which has an equity options turnover of Rs 3,000 crore per month, in order to understand how a stock broker might earn from rebates –
Equity Options Turnover | NSE Charges (per lakh) | Payment by SAMCO |
Up to Rs 3 crore | Rs 2,500 | Rs 7,50,000 |
Rs 3 – 100 crore | Rs 50 | Rs 4,85,000 |
Rs 100 – 750 crore | Rs 47.50 | Rs 30,87,500 |
Rs 750 – 1500 crore | Rs 42.50 | Rs 31,87,500 |
Rs 1500 – 2000 crore | Rs 37.50 | Rs 18,75,000 |
Above Rs 2000 crore (2000 – 3000 crore) | Rs 30 | Rs 30,00,000 |
Total amount paid by SAMCO |
| Rs 1,23,85,000 |
The broker, on the other hand, would charge an options investor a flat rate of Rs 50 per lakh options turnover. Thus, for a monthly turnover of Rs 3,000 crores in equity options, the broker would collect a total of Rs 1,50,00,000. This leads to a gain of Rs 26,15,000 per month. Moreover, this is a case study of one asset class for one exchange. There are multiple exchanges like NSE, BSE, MCX, etc. and various asset classes like equity delivery, equity options, futures, etc., which would, thus, lead to a significant source of income for a stockbroker.
This change is expected to significantly reduce the income of brokers, particularly those, who have relied heavily on these rebates for their revenue. The initial reactions from industry experts and owners of stock broking companies indicate a deep concern with a warning of prospective restructuring.
According to Nilesh Sharma, Executive Director of SAMCO Securities, the approximate revenue loss for all brokers could hit Rs 2000 crores. This shift is particularly concerning for firms like Zerodha, which has been a pioneer of the discount broking model in India and relies on rebates for 10% of its overall revenue, a figure which has increased significantly in the past few years driven by an exponential rise in F&O trading along with a gradual increase in equity delivery. Similarly, Angel One, the largest publicly listed stock broker in India, also reportedly derives about 8% of its revenue from rebates, which contributes significantly to its pre-tax profits. Nithin Kamath, co-founder of Zerodha, with respect to restructuring their business model, suggested that the firm might have to let go of its zero-brokerage model for equity delivery and increase fees for F&O trades. This sentiment is echoed by analysts who believe that brokers will have to adjust their business models to accommodate a new fee structure.
Adjustments in Business Models
The decision made by SEBI regarding the labelling of charges will undoubtedly have consequences for discount brokers and their business models. They will experience a decline in their rebate revenue, which provides firms with the financial flexibility to focus on their growth and expansion. However, as all the chances to earn that revenue have vanished, the brokers will now face considerable challenges in pursuing their expansion and growth goals. As a result, these platforms must either restructure their revenue models or look for alternative ways to cover those losses.
One potential change may be introducing or increasing brokerage fees across various asset classes. For instance, discount brokers who previously offered free equity delivery may now implement nominal charges. Additionally, brokers might increase the brokerage charges on F&O, which have become increasingly popular among young retail investors, possibly doing both simultaneously. However, these increases in charges may impact retail investors less than anticipated, and in contrast, it will lead to more uniform rates across the platforms. Therefore, even though the brokers might face a considerable impact on their revenue, a retail investor might not feel it due to the sheer number of investors present in the market.
Final Impact on Investors
The bold decision by SEBI has stirred up opinions in the market, especially about the end of the zero-brokerage era. However, a closer examination reveals that it is not necessarily imminent. It is necessary to note that even if trading platforms start levying brokerage charges on the equity trade, such charges will remain minimal and uniform across the platforms due to the competitive nature of the market, which will ensure benefit to the investors.
The competitive landscape of the Indian brokerage market plays a crucial role in determining pricing strategies for all its players. Brokers cannot afford to let go of their end clients by imposing exorbitant fees to recover their losses from the ending of rebate revenue, especially due to the significant traction of equity transactions in the stock market. The brokers can restructure their business models rather than losing out their clients which no business can afford.
For example, Motilal Oswal, commenting on Angel One, said, “Angel One has multiple levers to offset this change: increasing the brokerage rates by Rs 3 per order and levying account opening charges as other brokers do.” This shows that by making slight changes in their business models, the brokers will be able to recover their losses.
Thus, the notion that the end of the zero-brokerage era would lead to a major cost increase for equity investors is not so convincing. Moreover, in India, only a few brokers offer free equity brokerage, such as Zerodha, Angel One, Dhani Stocks, Fyers, etc., which shows that most of the other trading platforms, like Groww, Upstox, HDFC Securities, etc., already levy brokerage charges on equity delivery. While the charges may increase across the board, once the circular comes into effect, however, the competitive nature of the market of brokers will help control them. The circular aims to enhance transparency and informed stock trading by eliminating extra or hidden transaction costs, ultimately assisting investors in making well-informed and rational investment decisions. In addition, the overall long-term objective is to prevent excessive trading in futures and options, which has witnessed a sharp increase in recent years and potentially resulted in increased risk, as seen in SEBI's circular and recent actions. This regulatory action is a step in the same direction, meanwhile, also promoting a more positive trading environment and protecting the interests of investors.
Conclusion
In conclusion, the circular will have a noteworthy financial impact on brokers, especially those who used to rely on rebates for their revenue. However, it is unlikely to lead to a significant cost increase for equity investors due to the competitive nature of the brokerage market. The SEBI’s “True to Label” circular is an effective regulatory action that aims to bring transparency and uniformity in transaction charges levied in the share market, which shows that SEBI will do everything to regulate the market for the good of everyone. It will be intriguing to see how brokers restructure their business models and diversify their offerings to retain their clients and sustain their competitive edge in the market. Regardless of the strategy, it is clear that the days of relying on rebate revenue are over, and brokers must find some other sustainable ways to generate revenue. Ultimately, it can be deduced that the SEBI's decision is in the direction of creating a more informed, transparent and accountable stock market environment, aiming for the betterment of the investors.
Even though the transition might be challenging for market participants such as brokers, it may not significantly impact the investors in terms of cost. The intention of the market regulator lies in the long-term benefits of a more efficient and trustworthy market.
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