Sitting in his sprawling office located in the far western suburb of Mumbai, Ashish Shah, the founder partner of Morpheus Financial Services is not very comfortable talking about the markets and his own business. The reason being that Ashish has been a sub-broker all through his life. He began in 2001 and has journeyed through some major cycles that the market has been through between then and now. In fact he forms a part of the breed, which has surfed through the dream run of the Indian stock market between 2003 and the early part of 2008. It was a time that set the cash registers ringing for stock brokers and investors alike. Both made huge money and riding on the back of the irrational exuberance that followed this seemingly secular Bull Run, many new players jumped into the fray to corner a pie of the Indian broking business.

The result was an overcrowding of players, which led to a massive under-cutting of prices in a bid to capture the market. Everything was all right as far as the market kept on going up. The volumes took care of the margins, which were shrinking to keep pace with the declining prices offered by the competitors. The real challenges are appearing now considering that the tide has turned over and the volumes have dried up in a sluggish market. The big hit, which came at the beginning of 2008 and halted the northward march of the markets, has had an impact on the fortunes of the broking industry.

The effect of the hit has been so strong that incomes have almost halved from what they used to be at the peak of the market. “In fact, at the current levels the incomes have come down 50 per cent from what it used to be even three months back.” says Ashish. Press him further and he candidly admits that the level of his income three months back was down by almost 50 per cent from what it was at the peak of the market. If this really is the situation on the ground level, is it not something to worry about?

So, What’s Ailing Brokers?

Inflation, rising interest cost, a gloomy global economic scenario, the Lehmans of the world and the Greeks have all come to haunt the markets over the past three odd years. Not to say that the market has not recovered from where it went to in the aftermath of the first crisis that hit the Indian shores in early 2008. However, investor interest has taken a huge beating post 2008, thanks to the sudden and massive wealth erosion after a really long upward movement. The volumes have shrunk and this has created a huge strain on the margins of the broking companies. “The biggest challenge as of today is lower volumes, lower yields and lesser participation,” says B Gopkumar, Executive Vice President of Kotak Securities. 

Gopkumar is not the only one who feels so. There is almost complete consensus within the industry on this point. “In today’s scenario, brokers are under considerable pressure mainly because of two reasons. First of all, the market has been moving sideways in the last 18 months or so. Brokers depend mainly on the revenues from the retail clients, who have not participated in the market for the last two years. Secondly, if you look at the composition of the trade, 70% of the market has become options. Another 15-20 per cent is becoming futures and the remaining 10 per cent is the cash market. As the delivery volumes shrink, brokerage also shrinks and so do the[PAGE BREAK]
revenues of the broking houses”, says Sudeep Bandopadhyay, Managing Director & CEO, Destimoney. Amit Majumdar, Executive Director & Chief Strategy Officer, Angel Broking, has this to say, “The situation is not really encouraging as of now. There is no denying the fact that the margins have indeed shrunk and this is largely due to poor retail participation, besides the almost nil foreign inflows. Most of the brokerages are seeing a drop in their revenues by close to 25 per cent on a QOQ basis.” But shrinking volumes are a matter of market sentiment. The moment the sentiment changes, the volumes are bound to return in a big way. After all, broking too is a cyclical business. “If you look at the broking industry history, there have been markets that are bullish, bearish and flat. We are passing through one of the phases right now. We will see this get past just as it has done so in earlier times too” says Nandip Vaidya, President – Retail Broking, India Infoline.

The fortunes of the industry are hinging closely on the turn that the markets are expected to take. “The broking business is very closely linked to the markets. Therefore, you can see that the cycle in the broking industry is quite similar to the market cycles. We had a very good run in the broking business for four to five years and then with the declining volumes the broking business too has been affected,” says Vineet Arora, Head Products & Distribution, ICICI Securities. How long will the pain of lower volumes and participation continue to haunt the market in general and the broking industry in particular? Well, this is really not the time to make very optimistic assumptions on that front. “We are of the opinion that the market volumes will come back in the second half of the current fiscal. It is a cycle that is faced by every industry and we are looking forward to recover quickly” says Gopkumar.

This is a sentiment, which is also closely shared by Arora. “These are headwinds that are faced in every industry. We can say that we are still bullish on the broking business for the long-term perspective. One thing that I can see in this perspective is that if the investors’ want to make money in the long term they have to come to the equity markets. This is where the real returns are,” Arora adds.

Growth, Expansion And The Pain

While there have been reports, and of course there is no denying the fact that the broking industry as such is surely going through some pain at the moment, there is also a strong view-point that this is as cyclical a pain as it could be for any other industry. But what lies at the centre of this pain? Is it really just about declining volumes? If you look at how the industry has done over the past few years, you would realise that a lot of it is due to the mind-less expansion that has happened in the industry. This primarily has been due to the fact that the Bull Run, which spread across 2003 and 2007, saw the fortunes of many change for the better. The expectations of a secular bull run for the rest of our lives saw many enter the market, whether as brokers or as investors to mint the millions that were presumed to be waiting in the wings. This hurt the industry as well as the investors in a number of ways.[PAGE BREAK]

Quality Of Services

Expanding businesses are a natural phenomenon when the going is good but any mindless expansion without the capacity to provide quality services has always been detrimental. This is particularly so for consumers. With inefficiencies creeping in, customers have been left to the mercy of relation-ship managers who probably know much less than the client himself. “Today there are six to seven broking houses that are listed. To sustain, to gain market share and also to tackle the pressure of giving better returns to the shareholders has made the competition more intense. The result or the aftermath is that the service offered to the customer or client gets hampered,” says Gopkumar.

The Undercutting Effect  

One of the worst things that has affected the broking industry is its own doing – undercutting. The falling levels of brokerages that are being charged and used as a bait to get in as many customers as possible in their fold has actually turned out to be the worst scourge for the industry itself. According to Gopkumar, “In the earlier days when we had the dream run the scenario was completely different from the present one. At that point of time the brokerages were at a level of 25 to 30 paise. But with the expansion that happened it came down to the level of one paise. It is very hard to manage with this brokerage.”
However, undercutting in prices has largely been a game played by the smaller players. “We have never participated in the price war and have added value to our customers in terms of research, services and consistency in terms of our trading platform. It is not healthy for any industry to get into a price war and we have never participated in it. We have been a leader in the online segment and continue to do so,” says Arora.

Shift In Core Business

Another trend that has been observed is that many broking houses today have diversified into other related segments. This has more or less relegated broking to the back-ground especially since the margins in this business have shrunk. There is a thought process, which defends this move of the broking houses. Says Bandopadhyay, "Expanding into other financial services is nice idea as it will save you from business cycles in broking industry. I think the broking houses must aim towards becoming a financial organization."

Selling insurance, mutual funds or bank deposits has become far more lucrative on one hand and also provides an opportunity to offer clients a complete suite of products - something that is desired by today's investment savvy client. According to Vaidya, players in the broking industry are sitting in the middle of a market and if they can combine advisory with other products it will certainly help them in earning revenues from other segments.[PAGE BREAK]

“What I am trying to refer to here is that the broker should combine execution with good advisory. When you are addressing a customer, s/he may need insurance and may also be looking for investment opportunities in mutual funds other than equity. Therefore, there is no harm in providing other services or getting into other businesses. It is more convenient for an individual if s/he gets all the services in a single basket,” he points out. Vaidya is not the only one who thinks so. Another view on this is Majumdar’s perception of the entire diversification process. “In our opinion, there is nothing wrong in diversifying but all such diversifications have not been able to attain the scale needed to make any difference. Despite these diversifications, broking continues to remain more than 70 per cent of their revenue pie,” says Majumdar.

Loss Of Institutional Business

A very significant hit to broking houses comes from the loss of institutional business. Bandopadhyay opines, "Margins are wafer thin in domestic institution business. I do not think that big institutions are themselves becoming brokers. If you wear a shoe, you do not go ahead and start a shoe making factory."

Many institutions, particularly those with a foreign pedigree, which were major contributors to the broking business earlier, have themselves seen through the benefits of being in this business. This has hurt too but will it continue to hurt? “To my mind, this has not been a good move by them. Most business houses have failed to create any flutter in the market. The business of broking is built over a long period of hard work. This business needs economies of scale. Economies of scale can only be built over a long period of time and by constantly perfecting the model. Customers are extremely sensitive to pricing and ser vice. Besides, large industrial houses have several other business interests. Hence, the promoters’ involvement in such ventures is not high. This business of broking needs intense promoter level engagement to constantly improve the model and remain profitable despite any yield pressures,” Majumdar states.

The Road Ahead

With the whole lot of expansion that has happened in the broking industry one thing is certain and that is the consolidation wherein the mantra would be the survival of the fittest. “These are extremely tough times for small brokerages that lack the scale. It is very likely that some of these brokers will tire out and give up. Hence, we believe that this could lead to a spate of consolidation moves by the larger players,” says Majumdar. While consolidation is certain, it would not happen just for the sake of happening. Adds Bandopadhyay, “World-over, there was a phase of consolidation. India is moving in that direction as well, not voluntarily, but market is forcing the brokers to move in that direction. We have not seen that kind of a crisis, though it may develop soon. I firmly believe that going forward, we will have these large pan-India brokers and the ones who would cater only to the niche class. The mid-size brokers would all but exit.”[PAGE BREAK]

Gopkumar feels that there are many other factors as well that would be looked at before the broking houses consider acquiring others in the business. “I have faced this question many a times. There are also views that consolidation is inevitable in the market. However, I am on a different side of the coin. To buy a broking arm we have to look at the value we would be getting through the acquisition because at the end we are also a retail outfit where the client has to come and trade. Therefore, an acquisition should be a technological buyout provided that the acquirer benefits from technological upgradation” he says.

According to Bandopadhyay, "Stock broking industry has a huge and significant future in India. Shake up is bound to happen and probably would accentuate over a period of time." “The need of the hour is to attract the retail clients. Educate them about the markets and back your words with sound judgment. You have to give them the right advice. Remember, broking is a long-term business”, he concludes.

Lessons for Investors

The commoditization of the business has been both good and bad for customers. Investors have flocked places where the pricing has come down ignoring many vital facts at their own peril. A lower brokerage does not necessarily mean a better service. The quality of service, the quality of the manpower that a broking house hires and the resultant quality of advice that comes forth is what matter much more than the few paise that you save on your brokerage.

Broking has traditionally been an industry driven by trust between the broker and the customer. With superior technology in use, the investments involved in it calls for a proper cost benefit analysis for the brokers themselves. Saving costs and offering lower brokerages at the risk of adopting newer technologies for better servicing of the clients is what puts both ends in trouble. Even regulatory requirements call for substantial investments. Routine yet important things like sending out contract notes and bills for trades executed on time call for good quality of people to be employed. This is exactly where your brokerage helps the broker. The lower he charges you the poorer will be the quality that he could afford.

A financially healthy broker means your funds are always in safe hands. It means a timely payout for all your credits in any market condition. And this would depend on how much the broker makes from his business. The healthier his margins the better and safer are your funds. It is therefore in your own interest to look at healthy brokers rather than run behind some who offer ridiculously lower brokerages.

The last but not the least important is the quality of advice that your broker provides you. Remember, Motilal Oswal’s strength as a broking house emerged only on the back of the strong research capabilities of the company, which helped its clients to create wealth. Bigger broking houses will always have the wherewithal to take a professional approach to the business by housing adequate capabilities. This is where the pricing differential too comes in play. The best way for you is to check out on the kind of services that are being offered and, which would certainly come at a price.

A consolidation in the broking industry is certain to throw inefficient and marginal players out of business. What one should really focus on is the quality of deliverables rather than the price. We are summing up our effort by putting forth our interaction with three stalwarts of the Indian broking industry. Each one has provided us with some very important insights into what one should be really focussing on.

Read on to find out what industry experts have to say about the broking business. [PAGE BREAK]

Motilal Oswal, MD - Motilal Oswal Financial Services

Being a part of the Indian capital markets for a very long time Motilal Oswal, as a firm, has probably been witness to all the major ups and down of the Indian market. Where do you think the market stands as of today?

Most of the negatives surrounding the Indian economy are already known and discounted by the markets. There are no incremental negative surprises – on inflation or interest rates or corporate performance – that remain to be factored in. However, how the US economy will fare post QE2 is not yet known. This will be the key variable to watch out for in the next 30 days. For now, I remain quite bullish on Indian markets. By March 2012, I expect the Sensex to decisively cross 21000.

Stock broking as a business has gone through a sea of change from what it used to be and what it currently is. What is your take on it?

The broking business is going through a challenging time right now. One must understand that it is a cyclical business. If you look at cycle period of five years; two years are very good, two years are above/above average and one year is bad. My sense is that market activities are going to pick up from here, and the investors’ participation will gradually increase. We are in the business for a long term and we have seen even tougher times earlier. In a good time we focus on top line growth and in times like these we look at cost optimization as well as many new initiatives. I have seen that real business building happens in tough times, where apart from costs we also have time to look at processes, technologies, training and many more issues so that the business can become better and scalable.

Do you think that mindless expansion by broking houses, particularly through the franchisee route, is what has hurt the industry badly?

When the time is good many broking firms expand in a big way.  Right now the problem is that the activity in the cash market has come down and hence brokerage revenues are down.  The business is also very competitive.

Where do you think the main hit has come; retail or institutional business?
The hit has come from both retail as well as institutional segments.

Institutional business was considered to be the money-spinner for the broking industry. Is it still the same?
In good times, both retail as well as institutional businesses are money-spinners, and in tough times both segments become less profitable.

Where has the change come in this segment, and how has it impacted industry players?
A huge rise especially in people and infrastructure costs has been hurting. Margins are impacted.

What is your take on the retail business?
Retail business follows a herd mentality. In the recent past the activity level is increasing.  Players like us, who have a good brand positioning and low cost distribution through franchisees, have a tremendous advantage over players who have hundreds of direct branches.

Cut-throat competition and a volatile market have been hurting the industry very badly. Where do you see the scenario going forward?
In India we have not seen any inorganic growth in this industry.  Therefore, consolidation will happen when weak players will go out from the market and strong players will emerge much stronger.[PAGE BREAK]

Parag Parikh, Chairman - PPFAS

What is your take on the present state of the broking industry?
Once upon a time broking was handled by a very closed club. It has witnessed a change with the setting up of the National Stock Exchange followed by the launch of internet trading and with the liberalisation that has happened particularly in the financial sector. The broking business has become somewhat commoditised. Previously, it was considered as a speciality but it has become a commodity now. So, I think that it is a natural phenomenon that many players will enter the space.

Is this commoditisation of the broking business good or bad for the investors?
The process has been good for the investors, as a lot of transparency has come in and the SEBI has played its role in a proper way.

After a dream run between 2003 and 2007, a lot has suddenly changed. Broking houses have been badly affected, with volumes on the lower side. What do you think is happening?
The market always goes through these phases. You will witness a bull phase as well as a bear phase with the expansion and contraction of the economy. The financial markets get a lot of attention as they are the most talked about markets in India. This happens with all markets and it will pass.

Many leading brokers have shifted away from their core broking business. Please throw some light on this.
There are two views on this. First, we are in a knowledge economy, and how many brokers do you think have really thought of giving the right advice to their clients? Broking or money management is basically a profession. As a professional you will do whatever is right for the client. However, this profession has turned into a business over the last 10 to 15 years. The set-ting in of the mentality of trying to make money by hook or by crook is where the whole professionalism of the market has gone away.

How has the mindless expansion by broking companies hurt the industry?
The broking industry has become overcrowded, and it has turned into a ‘business’ from being a ‘profession’. Every Tom, Dick and Harry has come into the market and is looking forward for his share of the pie. Investors too are looking for cheaper rates, instead of going with experienced brokers. This is playing a role in diminishing the quality of services offered.

What is your take on the price war that has triggered lower and lower brokerages being offered to investors?
I must say here that investors are very greedy. Let me take it this way—if you are ill, then will you go to the cheapest doctor? The answer is ‘No’. Then, why do you go to someone for managing your money only because they offer cheaper rates. The correct breed of investors will always choose the right path instead of looking for cheap rates. They are even not bothered about the brokerage, as they are not traders. In our organization we do not have F&O, and stay away from speculation. Therefore, my clients know that if they are paying me more, it is for the advisory. In other words, I can describe our company as an advisory that is also into broking.

Is there a need to cap the minimum brokerage?
No, once we start talking about the competition then we cannot have a minimum cap on brokerage. However, we can have a cap on the upper side, otherwise we will go back to the days  of ‘Licence Raj’.

Do you feel that there will be some consolidation in the broking industry?
Yes, there will be a consolidation process that will take place due to over-broking. This is part of the evolution.

Lot of institutions are now getting into the broking business. Please share your views on this.
Institutions are getting into the broking business mainly because broking is a very cheap business to get into, and it is very systematic. Today, everybody wants to get into all sorts of businesses, but if money-making is so easy then why isn’t everybody making money?[PAGE BREAK]

Kisan R Choksey, Chairman - KRChoksey

What is your take on the present state of the broking industry?
In recent years, the number of brokers has increased a lot and you can see that individuals who have money have made an entry as a broker and have reduced the brokerages to a large extent. This in turn has made the environment competitive. But these brokers have reduced the quality of service, as they do not have the experience to provide that in the right fashion.

Don’t you think that the broking community is itself responsible for the price competition?
The thing is that, price competition has been started by the new entrants and this has resulted in changing the scenario as a whole. They have com-promised the quality of services and have not been able to cater to their clients’ needs in a proper way. Many broking firms have resorted to salary cuts and job cuts. This is because the cost per client has gone up as com-pared to revenue per client.

Have you seen an increase in the number of dormant clients since 2008?
With the lack of momentum in the market, there has definitely been an increase in the number of inactive clients. Previously, the government use to take care of the market but more recently it has changed its stance.

Where do you think the broking community has taken a hit—on the retail or on the institutional side?
In the present scenario the charm of becoming a broker has gone down. With price competition, the industry as a whole has taken a hit, be it on the retail side or on the institutional side. Institutions too have started cutting their brokerages, which is not a good sign at all. The institutions look for-ward to the broking houses as a base to provide them with research and other services, but with the decrease in the brokerages the services provided by them have taken a hit. They have also to look forward to remain in the green, and costs have increased a lot in the recent past as you are aware of the packages that are being provided to employees. The big institutions have sneaked in and have created their own broking arms, which in turn have further increased the competition levels. Many brokers have been shifting their line of business as they are selling a lot of other products. Broking as a business is taking a backseat as they are not finding it remunerative enough because of intense competition.

How do you think this is hurting the industry?
See, the industry has become a place where only the best will survive. With the increase in the level of com-petition, there is no other option left but to look forward to other opportunities that will help them survive. On the core broking side, until and unless there is a cap in the minimum brokerage, we will see that many players will move out of it having incurred losses.

Do you see consolidation in the industry going forward?
With the prevalence of such low brokerages, the smaller players will be forced to shut shop because they will not be in a position to cope up with the increase in expenditure and sustain at these levels. Hence, there will be consolidation in the space.

How do you think all these developments are affecting the investors?
See, the thing is that if you want good advice then do not fall prey to cheap brokerage rates. In the end that will hurt your own wealth creation.

According to you where is the broking industry heading?
At present, it is very important that there should be a basic code of conduct set for the broking industry. Otherwise, the broking business will turn into a commoditised model