Consolidation among brokers is good news for the markets

The broking industry is paying for the excesses of the past despite a bull run in the market

In an ideal world, a new high in the equity markets would have meant brokers announcing bonuses, opening new branches and giving their ‘expert’ opinion on TV. But these are not normal times. Markets touching new highs have more to do with constant infusion of liquidity from the US, European Union and now Japan than with fundamental drivers. Markets are living on borrowed time and definitely borrowed money.

 

Even as Indian markets have touched new highs, over 500 brokers have shut shop. Brokers are looking at alternate modes of survival. They are selling everything from furnishings, Pizzas and some have started coaching classes. Those who would like to continue with their operations are merging together to create a bigger entity and cut costs by sharing common resources. But is that enough to keep them from falling apart? Is broking industry doomed to fail for the time being? And more importantly, is this trend visible across the globe or is it specific to India.

 

To answer that, let’s look at the reasons why the sector that once offered the best pay packages in the country is in trouble 

 

At the peak of the previous market boom in 2007-08, a number of brokers went on an expansion spree. They hired anyone who could spell finance (that’s how most of the MBA's in that era were hired), they gave away franchisees to anyone who asked for it and finally they got themselves listed and bought real estate as though it was getting scarce. But the Lehman crisis changed the tide and most of them saw their clothes washed away. More than their own money, what they lost were clients and their trust.

 

Six years have passed since, but clients have not come back despite markets being on a bull run.The investors have lost their trust in equities as an asset class and as for their trust in brokers, the lesser said the better. Even as brokers say that the key differentiator among brokers is the quality of research calls, none stood the test of time. It’s probably the only profession in which an ‘advisor’ alights from a train to offer his ‘expert view’ to a client who drives a seven figure car.

 

And someday, the high cost operation had to come down with the fall in the market. With fewer clients to chase and ‘research’ no longer a selling card, brokers started to bring down broking rates. Further, clients also moved from the cash market to the options market where the brokerage rates were low. Today over 90 per cent of the volume in the exchanges are from derivative markets, where brokerage yields are one-fourth that of the cash market. 

 

While brokerages are crying over fall in volumes, exchanges are witnessing record volumes. So where are these volumes taking place if not with the broking houses. Almost all listed brokers have seen a fall in revenue and profit, even as exchanges have seen a pick-up in volumes. 

 

Volumes have shifted from Indian brokers to foreign ones, especially institutional and high net worth clients(HNIs). Further, there has been a pick-up in proprietary and high frequency trading also in foreign broking firms. To add to the problems of brokers, banks who now have broking arms have grabbed a large share of their clients.
 

Unfortunately, the turmoil has largely affected Indian brokers now. Foreign brokers who were badly affected closed shop in 2008 itself.Indian brokers kept their operations running in the hope of a revival in the India story. But looks like, most of them have now given up.

 

A look at the financials of most of the brokers who continue to operate shows that they are making profits only on account of their lending business. Their normal broking business is barely breaking even, but it offers an opportunity to make money from their clients through lending or margin funding. This is where they score over banks who have to follow strict rules, while brokers get away by stretching themselves in certain cases.

 

But there are fewer clients now who are seeking such funding. This is what gives hope that the rally will last for some more time. In order for a rally or a financially induced rally like the present one to break we need more ‘suckers’ in the market. With fewer brokers, there are fewer ‘suckers’ in the market. The bubble is not yet big enough to burst. We need more people (read brokers) to blow the bubble.