Blow to discount brokers like Zerodha as SEBI bats for uniform charges by MIIs; how will you be impacted?

In a massive blow to most stock broking firms, market regulator SEBI has directed all stock exchanges, depositories, and clearing corporations (collectively known as market infrastructure institutions or MIIs) to charge transaction fees from brokers on a uniform basis, doing away with the current system where these charges varied greatly and depended heavily on broker's trading volume or activity. The new rules will be in effect starting October 1, 2024.

Generally, stock exchanges like BSE and NSE charge a specific, slab-based transaction fees from brokers like FYERS, Zerodha, Groww and Upstox, depending on the slab within which their overall trading turnover falls into. The higher the broker's turnover or trade volume, the lower the transaction fee they end up paying. With SEBIs new guidelines, firms like Zerodha and Upstox will have to bear a significant financial brunt going ahead.

The same was very visible in the market's movement today, with stocks of most stock broking firms taking a serious hit. Stocks of Angel One tanked by 8.72%, while Geojit Financial Services dipped by 6.68%. Following their close lead was Motilal Oswal Financial Services, which shed 4.19% following the announcement.

The difference between what brokers charge the customers, and what the exchanges charges the broker is known as a rebate, and it makes for a significant revenue source for most brokers. As per Nithin Kamath, who heads Zerodha, "We earn about 10% of our revenue from such rebates. For us, this has increased from 3% to 10% in the last four years because of the massive increase in options turnover".

Options Trading: Of losses, heavy trades and addiction

If option trading were a sea, you'd find it full of Indians trying to make through, despite its strong, uncertain, and erratic currents. In 2023, Indian investors traded around 85 billion contract options, far more than any other country in the world. No wonder, 90% of revenue that Zerodha generated from such rebates were attributable to options trading alone.

However, for a novice investor, options trading is no easy endeavor, and as SEBI pointed out in 2022, only 1 out of 10 F&O traders managed to make profits. The average loss amount was a staggering Rs 1.1 lakh. But amidst soaring trading volumes post Covid, brokers made merry with high rebates and hefty profits, which is why this move comes as an unpleasant surprise to many.

According to Tejas Khoday , co-founder and CEO of FYERS, this model threatens to destabilize the discount brokerage business completely. "This revenue stream, which constitutes between 15-30% of the larger brokers' revenues and over 50% for deep discount brokerages, is crucial for sustainability. Without this income, many brokers may have to introduce brokerage fees to remain viable".

"In the short term, traders may benefit from reduced costs. However, in the long term, brokerage fees will likely rise as intermediaries attempt to recover revenue losses. While retail customers are charged the standard slab rate, brokers benefit from a lower fee due to high turnover. For instance, the base exchange transaction charge for options is 5,000 rupees per crore, but a broker with high turnover might be charged only 4,000 rupees per crore. The 1,000 rupees per crore difference constitutes the broker's income, which stands jeopardized", he continued.

In his blog post, Zerodha's Kamath also hinted at a possible fee hike after this mandate. "As a business, we may have to introduce a brokerage fee for equity delivery investments, which is currently free, or/and increase F&O brokerage. In all likelihood, we will probably have to let go of the zero brokerage structure for equity delivery trades which we have been able to offer for the past 9 years", he said.

As Devam Sardana, Business Head of Lemonn, a new-age stock broking firm notes, this move will definitely hit brokers' revenue streams especially those with scale. "With scale, many brokers enjoyed the benefit of charging users a certain amount of transaction fees and eventually gaining a rebate from exchanges based on their turnover. This essentially created arbitrage and created a growth flywheel for brokers".

As bigger brokers' revenues became higher, he explains, it allowed them to subsidize certain products and gain even higher market share. But this move does 2 things: it levels the playing field for all brokers and puts pressure on brokerage fees across the board.

Chance for small brokerages to shine

But Trivesh D, COO of Tradejini, a Bengaluru-based stock broking firm, calls this a watershed moment for small and midsized brokers.

"For years, small and mid-sized brokers have struggled to compete with larger brokers who enjoy significant discounts on transaction charges, particularly in the Futures & Options (F&O) segment. Now, they will finally get a level playing field. This will likely have a profound impact on brokers with high turnover. These brokers, who previously benefited from hefty discounts, will now face a more equitable charge structure. This change promotes fairness and transparency in the market, ensuring that no single entity has an undue advantage based on volume alone," he continued.

However, Nilesh Sharma, President & Executive Director of SAMCO Securities, sees it as an adverse move, one that will disincentivize brokers from working towards generating huge turnovers, thereby impacting market making.

"We estimate the broking industry revenue (and, in turn, profitability) to be hit by around Rs 2,000 crores. This will lead to an increase in brokerage rates, as it will become unsustainable for the broking companies to take such a big hit on their profitability. Thus, this will lead to a drastic reduction in trading volume and the resultant price discovery," he cautions.

How does the customer benefit?

SEBI has asked MIIs to ensure that the charges that are recovered from end client remain "true to label." This means that MIIs should receive the exact amount that was levied by brokers on individual traders or end clients. While brokers recover these charges daily, MIIs are paid on a monthly basis, depending on the trade volume slab a broker falls into, leaving grounds for broker members to tinker around or confusing the end client that the actual fees charged by MIIs are high.

But, as Tradejini's COO explains, "for end customers, this move promises several benefits. A uniform fee structure means that the savings from transaction charges are more likely to be passed on to clients rather than being pocketed by large brokers.".

All in all, this could mean a sharp reduction in transaction costs for end investors, thereby making trading financially accessible and affordable. It will also foster a competitive landscape where brokers are encouraged to compete on service quality and pricing rather than simply relying on their ability to secure volume-based discounts," he signs off.