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Broking industry at crossroads: 2020 and beyond

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The year 2020 has been an unimaginable roller coaster ride and to be remembered for times to come!

Broking industry at crossroads: 2020 and beyond
Authored by Tejas Khoday
The year 2020 has been an unimaginable roller coaster ride and to be remembered for times to come! From the debilitating effects of COVID-19 to the crazy market volatility during the ensuing lockdowns, to a slew of sweeping reforms undertaken by the market regulator, SEBI has stirred and shaken the market participants thoroughly.
While new investors count increased by the millions during the year, only a few well-established brokerages were able to derive the maximum benefits. Being associated with capital markets for many years, experienced hands find it as one of the fastest-evolving regulatory phases of this generation. Perhaps, an equivalent of the early 1990s when SEBI replaced the Controller of Capital Issues (CCI) to modernize India's markets.
For years, unfair and non-compliant practices of several brokerage firms destroyed immeasurable amounts of investors' wealth. This is a well-known and documented fact, encountered and acknowledged by most seasoned investors in their investing journey. A crisis of public confidence arose as few brokers went off-track and defrauded investors, or went bust due to overleveraging/misplaced risk management priorities.
After the IL&FS and Allied Financial fiasco, news of a massive scandal at Karvy Stock Broking sent everyone into a tailspin and it didn't stop there! In 2020, around 18 brokers defaulted on NSE & BSE. It was time for SEBI to take matters into their own hands, to change the approach and regulations, in order to protect retail investors. Witnessing things go from bad to worse from side-lines wasn't making it any better for other brokers.
What's changed and how it impacts brokerages:
Standardized Leverage
Most brokers offer similar market access across exchanges and a vast majority also use the same platforms provided by a common software vendor(s). To differentiate from others, a few brokerages offered margin trading & high-leverage products to enable in sustaining the high brokerage charges that prevailed until recent times. Traders usually don't worry about incurring additional charges as long as the broker allows trading with lesser margin money. However, things changed after SEBI decided to curb this practice, as they believed that excessive leverage was detrimental to retail investors, by introducing an upper cap on intraday leverage for all segments.
Many debates and discussions ensued among market participants, but SEBI restricted intraday leverage of max 5X for equities and mandatory SPAN margins for derivatives. This totally nullifies any competitive advantage that traditional players enjoyed so far. The phased implementation of this new rule offers sufficient time to all brokerages in adjusting to the evolving landscape.
Peak Margins
To ensure upfront margin collection, a peak margin mechanism was introduced to help stock exchanges monitor fund availability, for trading clients with open positions. This is done by capturing screenshots of the brokers' trading systems at random but 4 times during the day, for surveillance purposes. This enables exchanges to track intraday activities at brokerages, which wasn’t the norm earlier. They were mainly concerned with End of Day (EOD) positions at a broker level and the subsequent pay-ins/pay-outs & settlements.
A broker's Risk Management System (RMS) was and still is a pandora's box to a large extent with no tracking mechanism. But the current changes will help strengthen risk management processes, and ultimately reduce the risk of defaults at times of high volatility. Is this good for brokers? Yes, especially for those ignoring risk management to focus on short-term returns.
Penalties on margin shortfall can't be passed on to clients
SEBI decided that, when it comes to penalties, the buck stops with the brokers. As per new rules, brokers aren’t allowed to pass on the penalties on margin shortfall to clients. They state that if the client doesn't have sufficient margins, he/she should not be allowed to initiate the position in the first place. If allowed, the broker would be liable to pay penalties. This is a highly controversial rule, disputed by almost everyone, for various reasons.
However, at the moment, SEBI's intention is to curb a brokers' ability to circumvent the upfront margin collection rule by passing on penalties to their clients. All in all, not good news for brokers and there exist genuinely disputable situations, for which the exchanges need to provide additional clarity.
Pledge/Un-Pledge mechanism
Few brokers allow a client to trade even without any funds in their accounts. How’s that possible? A client has demat holdings that are used as collateral, even if not pledged. If a client incurs losses, their shares will be sold to recover the losses and settle trades. More often than not, clients aren’t aware of its working and due to their naivety, take on additional risks than they are prepared for, finally landing in trouble. To prevent brokerages from misusing clients' securities by pledging them without their knowledge or authorization, or misusing it to further their own agenda, SEBI implemented this new rule.
Additionally, it also prevents brokers from pledging clients' securities and using the funds raised to prop-trade, to provide collateral to the Clearing Corporation (CC) or Clearing Member (CM), to provide short-term funding to other clients or to divert funds to their other business ventures, etc. While few bad apples indulged in such practices, it resulted in a serious reputational crisis. However, the impact on broking houses may not be much, but, in September, it did cause an operational nightmare for a week but overall, didn’t make much of a difference.
Demat Account without POA
The Power of Attorney document had become a norm due to the inefficient DIS system that made it unviable to settle trades on time due to the offline operational hassles. Despite its widespread use of POA, it has been a disputed instrument, and has been misused by far too many unscrupulous brokerages.
Thankfully, SEBI has taken steps to prevent the possibility of such malpractices in the future. Recently, CDSL introduced a mechanism through which clients can operate their own Demat accounts using a TPIN. This gives clients complete control of their securities and prevents unauthorized access. This move will enhances confidence in capital markets and the sanctity of a Demat account.
Quarterly Settlement cycle may reduce
To prevent idle funds from lying with brokers for a long period of time, SEBI introduced a quarterly settlement mandating brokers to return any amount in excess of Rs 10,000 to the clients' designated bank accounts after 90 days. The implementation of this rule has become stringent in recent years and going forward, the timeline may reduce to 30 days if credible sources are to be believed. If it happens, it will be good for investors as it will ensure that unutilized funds will be returned to their account(s).
However, traders acknowledge that it is an unnecessary hassle that will eventually cause them to miss trading opportunities. If implemented, it can be an operational challenge that everyone will have to adjust to over a period of time.
What lies ahead for new-age brokers and broking industry?
Until a few years ago, investors barely showed any interest in stockbroking as it was considered a saturated and old-world business. However, recently, there has been a lot of interest to capitalize on start-ups in fintech space.
The opportunity was always there and has only grown larger. While we're heading into 2021, users' expectations as usual are a few years ahead. It's a good problem to be dealing with, as investors embark on a remarkable shift from physical to financial assets in the coming decade.
Having said that, today, many traders may be livid by SEBI's seemingly harsh policies to restrict retail from trading. But if one flips sides and view it from their perspective, the dynamics are very different. It's not easy to regulate so many brokerages through exchanges that tend to have vested interests in generating business from their trading members. When everyone starts to cross the line in the sand, new boundaries will have to be created. After all, it's being done in the interest of protecting & potentially preventing millions of retail investors from falling prey, just like their predecessors.
Tejas Khoday is Co-founder and CEO at FYERS

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CompanyPriceChng%Chng
Axis Bank747.05 -9.25 -1.22
Dr Reddys Labs5,361.05 -50.20 -0.93
Cipla944.35 -6.20 -0.65
HCL Tech995.15 -5.15 -0.51
Britannia3,466.10 -15.90 -0.46
CompanyPriceChng%Chng
Axis Bank747.45 -8.70 -1.15
Dr Reddys Labs5,363.95 -45.20 -0.84
Sun Pharma700.10 -3.45 -0.49
HCL Tech995.00 -5.00 -0.50
HDFC2,452.15 -12.00 -0.49

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