Light at end of tunnel for stock broking

WITHOUT CONTEMPT

Early this month, the Securities and Exchange Board of India (Sebi) invited comments on a report filed by a committee constituted in January 2002.

The committee's mandate was to review the registration fee that stock brokers have to pay, in particular, the turnover-linked registration fee payable in the first five years of their registration.

Curiously, although the report is dated November 28, 2003, the report has been brought into the public domain for comments only now""almost two years later.

Why the report was kept under wraps is unclear, but the report has made some excellent recommendations relating to turnover-linked registration fee payable by stock brokers.

Since 1992, stock brokers have had to pay a fee linked to the turnover of trades transacted by them, either on behalf of their clients or on their own, on stock exchanges for the first five years of their registration.

For an aggregate annual turnover of up to Rs 1 crore, the fee payable is Rs 5,000. And for a turnover in excess of Rs 1 crore, the fee payable is one hundredth of 1 per cent of the amount.

This is a huge amount and admittedly cross-subsidises the regulation of other segments of the market, where intermediaries do not pay fees commensurate with their earnings.

For instance, merchant bankers, who mostly earn their fees linked to the size of the transactions they handle, pay a pittance as registration fee to Sebi in comparison with stock brokers.

The expert committee, headed by DC Anjaria, seems to have gone about its task quite scientifically and methodically. The committee got Sebi to conduct an inspection of operations of a scientifically chosen sample of brokers in 2001-02 and 2002-03.

This included a mix of brokers who primarily have institutional clients, those who have a retail network and those who mainly transact on their own account.

The committee found that in the equity segment, on an average, brokerage earned in 2001-02 was just 0.21 per cent and in the next year, it fell down to 0.17 per cent in the equity segment.

The story of debt brokers is even more striking. Brokerage in debt trades was merely 0.0025 per cent in 2001-02 and 0.0029 per cent in 2002-03. On derivatives, brokerage for the two years was 0.0634 per cent and 0.0529 per cent.

When the Sebi regulations were written in 1992, brokers earned about 2 per cent in brokerage, and it was felt that if their fees were linked to their turnover, it would help Sebi get started with regulating the market.

A legal challenge to the fees failed because the fees are indeed legal, but the economic and commercial propriety of singling out one section of the market to fund regulation of the rest, was suspect.

Adopting the findings of the inspection, the committee has computed a presumptive brokerage-earning benchmark. The committee has arrived at a benchmark brokerage of Rs 10,000 for the equity segment, Rs 500 for the debt segment and Rs 5,000 for the derivatives segment, for every Rs 1 crore of turnover.

The committee has accepted the willingness of brokers to pay 1per cent of the brokerage actually earned, and applied the benchmark brokerage rates to come up with a recommended fee payment of Rs 100, Rs 5 and Rs 50 for every Rs 1 crore of turnover in the equity, debt and derivative segments respectively.

This is equitable and sensitive to the fact that brokers no longer make the kind of money that the market believed they did in 1992. Indeed several brokers have suffered badly.

Even consolidation and sale of the broking business has been jeopardised with Sebi initiating the five-year turnover fee with every change in control.

Given the equitable fee payment recommended, the committee has proposed that the fee should be perpetual and not just for the first five years of registration. However, the committee has recommended that such fees should be applicable only to new registrations and not to brokers who have already paid fees on the basis of the existing scale of fees.

For brokers who are still in the process of making such payment, the committee has recommended that Sebi may devise a scheme of migration to the new model. Importantly, the committee has recommended that Sebi should review the state of the market every three years to consider tweaking the variable registration fees.

This is an important opportunity for Sebi to clean up the mess in regulation of stock brokers. This is similar to the bold and well-reasoned migration that we achieved in the telecom sector by migrating from the high-cost auctioned license fee to the revenue-sharing fee model in the telecom sector.

The author is a partner of JSA, Advocates & Solicitors. The views expressed are his own

somasekhar@jsalaw.com