Discount brokers step in as big players exit

A new breed of discount brokers, charging investors only a flat fee for trades in the currency, stocks and commodities exchanges, has emerged, as full-service stockbrokers face dwindling revenue with retail investors turning their back on them.

Discount brokerages charge a fixed rate of, say, Rs 20 per transaction, whether the value of shares transacted is Rs 5 or Rs 5 lakh or Rs 5 crore. With full-service brokers the practice is to charge brokerage in proportion to the value of shares traded. Put simply, higher the transaction value, the higher is the broking charge.

Zerodha, Compositedge, RKSV and Achievers Equities, among others, have emerged in the past two or three years. They attract small investors and are willing to trade on their behalf in stocks, equity derivatives, currency derivatives or commodities for a fixed fee, irrespective of the volume of transaction.

Their emergence comes at a time when several big full-time brokers, including HSBC, Brics Securities and IIFL, have decided to exit retail broking. Many other full-service stockbrokers, such as Geojit BNP Paribas, Edelweiss Securities, Emkay Financial Services and Motilal Oswal Securities have seen lower volumes, especially from their retail/small investor segment. Even brokers such as Sharekhan, ICICIdirect and Indiabulls are seeing declining growth in their retail broking units.

Geojit BNP reported a loss of Rs 56.84 crore in the September quarter; in the June quarter it had made a Rs 5.89 crore profit. The situation is better in Motilal Oswal Financial Services where the net profit in the September quarter rose to Rs 16 crore from Rs 5.34 crore in the June quarter. Emkay Stock Broking posted a net loss of Rs 2.46 crore (Rs 2.29 crore loss in the previous quarter). India Infoline’s profit fell to Rs 12.11 crore from Rs 12.80 crore.

After the 2008 crash triggered by the global financial crisis, Indian stocks are yet to recover though other global markets such as the US, Japan and Europe have breached their peaks hit five years ago. This has forced retail investors to keep off the stock market, preferring to park their money in fixed deposits.

In the US the entry of discount broking firms such as E*Trade, TD Ameritrade and Charles Schwab in 1990s had forced big brokers such as Goldman Sachs and Bank of America to shut down their retail broking divisions.

But a similar trend may be seen in India, according to Nitin Kamath, founder of Zerodha, India’s first discount broker. “In India I see both discount brokers and full-services coexist with different business models,” he told Financial Chronicle.

According to him, Zerodha has a client base of 7,000 and clocks a daily turnover of Rs 4,000-5,000 crore in trades in currency, commodities, equities and equity derivatives. “We command nearly 70 per cent of discount broking business in India,” he claims.

India has over 20 million individual demat accounts, but a significant portion of these are either inactive or dormant.

The work discount broking houses do, like processing trades and all post-trade activities, are the same fore very transaction, whether worth Re 1 or Rs 1 lakh or Rs 1 crore. This explains the logic of their existence.

“We are catering to a knowledgeable investor who is comfortable with the computer at his home,” said Satish Kumar Dutt, co-founder and MD of Composite Edge, another discount broker, which charges Rs 18 per trade.

Though no foreign player is present in this space, E*Trade was present indirectly as a stakeholder in ILFS Investmart, which was acquired by HSBC. HSBC recently announced its plans to shut down the retail broking venture.

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Discount broking in India

An insight into discount broking in the Indian financial markets-
Discount brokers are slowly lining up the Indian financial markets offering online traders and investor’s unusually low brokerage on their transactions, steadily grabbing market share long held by conventional or full time service brokerage firms.
Discount broking is a pretty new concept in the Indian financial markets, although it’s been established in the International financial markets.
A sizable number of online retail clients in India have shifted or moved their trading activities from conventional brokers; who charge a percentage of the client’s transaction as brokerage, with a large number of retail investors still considering the option as confusion and alarm of opening a trading account with discount brokers is still prevalent among a majority of traditional retail investors.

This article is directed to the discount broking concept, how we as a discount broker operate, the pros and cons of trading with a discount broker and if the fear among traditional retail investors is justified.
Discount brokers offer fixed brokerage irrespective of the value of your transaction. The brokerage ranges from Rs. 10- 30 on every transaction carried out by a client.
So, in reality if you invest in 1 share or 1000 shares of Infosys and place the order as a single transaction, you end up paying ONLY Rs. 10- 30 as brokerage for the entire lot of Infosys shares compared to Rs. 75- 7500, if you do the same with a full service broker; assuming that you are charged a delivery brokerage of 0.30% and the current market price of Infosys is Rs. 2500. That’s enormous saving in terms of costs for an investor.
Similarly, a trader placing bets on futures and options with a discount broker also pays a similar brokerage irrespective of the quantity or the number of lots entered as a single transaction, compared to the 0.01- 0.05% charged by traditional brokers.

How are discount brokers able to offer these services at negligible costs without compromising on clients interests?
The answer is simple. A discount broker has low operational costs compared to a conventional broker, thereby passing on the benefits to clients, fully ensuring that a client’s interests are a priority and not compromised at any point.
The low cost model of a discount broker can be attributed to the following
Efficient and adequate management team
Leaner- trimmer work force leading to smaller office space, thereby cutting down on fixed costs in the form of salaries and rentals
Do not offer research and trading calls to clients. The best we could offer is guide clients to the right source
Sharp reduction in marketing costs, as clients mostly come on board either through referrals or word of mouth
Most of the communication is handled online, leading to large savings on variable costs
Very few branch offices

A full service broker on the other hand offers most of the above services, has a large work force with larger office space, leading to massive fixed costs, which are ultimately passed on to customers.

Pros and cons of trading with a discount broker-
Discount broking, as discussed above, can be valuable savings for an investor and trader, especially during adverse market conditions. But they are not suitable to all investors and traders
As a client, you have to understand the pros and cons before you decide to open your trading account or shift from an existing full time broker to a discount broker
Mentioned below are some of them

Pros-
All you need to get started is to connect to your trading terminal to a computer with a reliable internet connection
State of the art trading terminals
For clients on the move, you can login and trade using your cell- phones, I-pads and most mobile devices
Automated/ Semi- automated trading systems to generate trading strategies and place trades
Superb customer support
Online pay-in / pay-out of funds
No unsolicited trading strategies offered
Most of the communication and paperwork carried out online, saving time and energy
Online- back office to verify post trade related info
Extremely low brokerage, leading to hefty savings, particularly for high volume traders and large investors

Cons-
Only online clients are preferred although offline clients are permitted to trade at an additional cost
For an investor looking at a broker to offer trading strategies and signals, a discount broker normally may not be the right option.
If one is a small time and infrequent investor, the type of broker would not make much of a difference
Discount brokers may not be the first choice for investors who do have access to Internet
Investors looking ONLY for managed accounts may not find a discount broker suitable

Any trading or clearing member of an exchange is governed by the specific regulations of the “National Exchanges” and is constantly vetted by the SEBI. Any violation will lead to a member being barred, thereby losing the enormous deposits paid as members of the Exchange.
Brokerage is the revenue earned by the respective member of the Exchange and is determined by the broker after taking into account operational and other expenses. Although Exchange Members are not given a lower brokerage limit, the upper limit is specified by the respective Stock and Commodities Exchanges in India.

For an investor or trader, brokerage could constitute more than half the expenses incurred in case of a traditional broker, while in case of a discount broker; it might only amount to a fraction of the cost.
Therefore, retail investors and traders who were sceptical of the operational aspects of discount brokers in India can be assured of the safety of their investments.

Finally, a discount broker is highly recommended, especially for large online investors and high volume traders.

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