Saturday, April 13, 2013

A case of going broke?

With market volatility making life difficult for equity-driven brokerage houses, the players are scouting for newer, innovative tools. But have their efforts really paid off?

Biologists have applied game theory to explain genetic mutations. Legal arbitrators have used it to understand negotiations. And brokerage houses are fast mastering it to muscle out competition with every means possible. For these brokerage outfits, it is an age where profits talk, survival of the fittest is the style of living, and constant evolution of their model is a necessary deed. But at what cost?

With the market continuing to misbehave, many broking houses that had mushroomed during the great financial markets boom (2004 to 2007) find themselves in a soup. As many as 48 firms were even forced to surrender or shut shops on NSE & BSE between July 2010 and June 2011. And for the lot of 1,800-odd that continue to breathe, most (predominantly dependent on equity broking) are struggling due to the continuous fall in revenue, which during the past two years has been as killing as a 25% drop on a q-o-q basis. This has left them figuring out: “what next?”

On the surface, the situation may not look as bad, because turnover (equivalent to the total values of deals conducted – both institutional & retail) of the domestic equity brokerage industry did grow by 46% in FY2010-11 to touch Rs.339 trillion ($7.48 trillion; as per ICRA). But a look at the particulars give wrinkles to well-wishers. 86% of the turnover during FY2010-11 was contributed by the low-margin derivatives segment (average broking yield of 3-5 basis points). On the other hand, the contribution of the lucrative cash segment (yield of 10-12 bps) continued to decline. As per ICRA, between Q2, FY10 and Q4, FY11, the average daily trading volumes (on BSE & NSE) in the cash segment fell by a high 33% to Rs.161.15 billion. This implied a fall in the share of the cash segment at the exchanges from 26% in Q2, FY10 to just 10% in Q4, FY11. This change in trading mix, coupled with sustained high competition that triggered a price war in a highly fragmented market, dragged down average rate of commission to 0.15% from 0.4%, ensuring a 1 bps fall in brokerage yield y-o-y to the sub-4bps levels in FY2011. In FY2010, the average daily turnover (ADTO) of emerging segments like options and commodities – which were once imagined to fuel growth – grew at 127% and 110% respectively. [Currently the ADTO of commodities is Rs.460 billion, with a broking yield of 1-2 bps or lower.] Another fast-growing segment is called currency trading (in which trading in India started in September 2008 and today, the ADTO is at Rs.450 billion with broking yield between 0.6 to 0.8 bps). These three tools appear attractive, but have not worked in the name of diversification. Reason: ultra-low yields.

Another not-so-successful attempt – in recent years, to create a diversified revenue stream, brokerage houses have ventured into capital market related funding activities. But while this move was expected to earn them money in a sunbathing mode, the outcome has been quite the contrary. The capital market financing book (which consists of margin funding, loan against shares & promoter funding) of 19 large brokerage outfits (tracked by ICRA; which has increased to over Rs.160 billion by March 2011 from Rs.120 billion in March 2010), has taken a beating due to a constant rise in cost of funding (courtesy: RBI’s rate hikes), and the failure to pass on the cost to the clients. Result: return on equity invested for the financing business is down from 15% to 12% (and even this is sans the operating expenses & credit costs).


Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
 
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