New-age brokerages rework risk management policies to tide over volatility

New-age brokerage firms, which have been instrumental in bringing in paradigm shift to the ways stock investing is done in India, are now facing perhaps the toughest battle since their inception.

Extreme volatility in the equity market and the deep plunge in crude oil prices have made these discount brokerage firms vulnerable to risks of ‘defaults’. In order to tide over such crisis, mostly induced by Covid-19 pandemic, these start-ups are implementing several measures to ring-fence their operations from such market volatility. While some have restricted intra-day leverages given to clients for trading, others have stopped trading in illiquid scrips.

In the light of recent losses arising out of crude oil derivatives, many have also disabled trading in this commodity, while some have increased margin requirement to cover any possible losses.

"A contract doesn't go into negative (zone) on a normal day. Given the unprecedented times, we have revised the margin requirement for clients. An additional margin of 300 per cent of the contract value is required now, one day prior to expiry day, on all open cash-settled commodity contracts expiring the next day. If sufficient margin is not available, the positions will be squared off automatically," said Nithin Kamath, founder & CEO of Zerodha told Business Standard.

Kamath said Zerodha is a well-capitalised business that does not cater to the large individual or institutional investor. “Our customers are more retail. So, the risk is more granular," he added. Zerodha, the market leader in the broking space in India, said it is facing a client default risk of only Rs 10 crore as compared to over Rs 300 crore faced by other brokerages.

Amid the Covid-19 crisis, the crude oil settlement price turned negative on April 20 on Nymex , which in turn was reflected in contracts in MCX. Due to this incident, Indian brokerages are staring at a client default of over Rs 300 crore, making it a rare incident for them.

"Safeguarding our customers has always been our number-one priority. Based on the current crude oil crisis, we have disabled trading in crude contracts and we are also restructuring our RMS (risk management system) policy, which will protect the clients in the future from any such events," said Puneet Maheshwari, Director at Upstox. Upstox is another startup in the new age broking space, which is backed by Ratan Tata and Tiger Global.

Anticipating volatility in equity market owing to COVID-19 pandemic, the Mumbai-headquartered firm has also restricted leverage trade in recent months. "Foreseeing these turbulent markets, we restricted intraday leverages to only certain high volume traded scrips almost a month back. As a practice, we have always blocked illiquid scripts for tradings," Maheshwari added.

Industry experts are of the opinion that discount brokers such as Zerodha, Upstox and 5paisa are better placed than traditional brokerage firms due to their high retail base. "One thing that works to their advantage is that the retail base is high and there are fewer relationship-based business decisions. So, the concentration risk is low for these start-ups," said a Mumbai-based stockbroker.

Apart from less of concentration risk, these firms are also well-capitalised with almost zero debt on their balance sheets. "Around 10 per cent of our revenue have been kept for covering these kind of events. We have not carved out any separate fund but we are well-capitalised to cover any losses," said Kamath of Zerodha. According to sources, the company has around Rs 800 crore of cash reserve in its balance sheet.

Similarly, Upstox is also well-capitalised with marquee investors. The company has raised around Rs 1,750 crore in September of last year from American fund house Tiger Global Management.

According to experts, these justify what new investors have flocked to the market by opening their trading accounts in these new age brokerage firms even at this volatile time. Zerodha alone has seen opening up of around 150,000 new trading accounts last month.