SEBI circular for MIIs: How it will impact brokerage firms

The latest circular by the capital market regulator Securities and Exchange Board of India (SEBI) on charges levied by market infrastructure institutions (MIIs) may significantly impact the revenue of brokerage firms and overall trading volume as well, according to experts.

SEBI, in its circular on Monday, July 1, communicated that MIIs, such as stock brokers, depository participants, and clearing members, would be required to levy uniform and equal charges to its members.

Until now, MIIs have followed a volume-based slab-wise charge structure, which, according to SEBI, can hinder them from ensuring equal and fair access to all market participants. The slab-wise charge structure impacts the level playing field between members owing to their size differentials.

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SEBI wants MIIs to redesign the existing volume-based slab-wise charge structure. It said the MII charges to be recovered from the end client should be "true to label." This means that if MIIs levy certain charges on the end client, they should ensure that they receive the same amount.

How do brokerages gain from a volume-based charge structure?

Brokerage firms charge their clients at the highest slab rate while paying the exchange based on a volume-based slab rate. The difference between these two rates constitutes the profit for the brokerage firms.

Nilesh Sharma, President and Executive Director at SAMCO Securities, explained it by an example. He said that NSE levies the following transaction charges on equity options:

In this scenario, a broker with a total turnover of, say ₹3,000 crore per month will have to pay the following as exchange transaction charges:

"Brokers would have collected a flat rate of ₹50 per lakh of options turnover from their clients, amounting to ₹1,50,00,000. Against this, it will pay ₹1,23,85,000 as exchange transaction charges. The difference of ₹26.15 lakh per month would be a net gain for the broker. This is like a volume discount being given by the exchange to the brokers generating high turnover," said Sharma.

Brokerages' revenue to take a hit

Exchanges levy a monthly transaction charge on the trades carried on their platform to brokers. This transaction charge is the primary source of any exchange’s income.

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Exchanges impose transaction charges on a slab basis every month, but brokers collect these charges from their clients daily. Brokers charge their clients at the highest slab rate and record the difference as net profit in their financial statements.

After SEBI's guidelines, stock brokers will not be incentivised to generate huge turnovers.

"The brokers will not have any incentive to generate huge turnovers, and the market-making activity will be adversely impacted. We estimate the broking industry's revenue (and, in turn, profitability) will be hit by around ₹2,000 crore. 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," said Sharma.

Many broking firms follow a zero brokerage model for equity delivery, which is considered one of the biggest factors facilitating the strong influx of retail investors. Experts see SEBI's move as a step to curb increased trading activity among investors.

"The government has expressed concern regarding excessive speculation in the stock market. In June of the previous year, the daily average cash volume on the NSE was ₹62,000 crore, which surged to ₹1.52 lakh crore—a two-and-a-half-fold increase. The low brokerage fees have prompted increased trading activity among investors. There is a pressing need to address this issue," said Sunil Damania, Chief Investment Officer at MojoPMS.

Damania underscored that one mechanism that enabled brokers to offer zero brokerage on cash delivery volumes was the 'rebate' provided by the exchanges. This can change now.

"With the elimination of this rebate, many brokerages will likely start imposing charges on cash delivery transactions or increase their fees for futures and options trading. This change marks an initial step toward regulating the market," said Damania.

Damania anticipates further measures in the upcoming weeks, possibly in the Budget announcement.

"It is expected that the government will introduce additional measures to restrain F&O (futures and options) trades, indicating more challenging times ahead for the brokerage industry," said Damania.

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To mitigate the hit on revenue, brokerage firms may do away with the zero brokerage model.

Zerodha's co-founder Nithin Kamath, in a post on social media platform X (formerly Twitter), wrote that the brokerage may need to reconsider its zero brokerage model or potentially raise brokerage fees for F&O trades after SEBI's circular on charges levied by MIIs.

Read more: Nithin Kamath says Zerodha may end zero brokerage structure for equity delivery trades after Sebi order; Details here

“Stock exchanges charge transaction fees based on the overall turnover contributed by brokers. The difference between what the brokers charge the customer and what the exchange charges the broker at the end of the month is a rebate, which goes to brokers. Such rebates are common across the major markets in the world,” Kamath said.

"With the new circular, we will, in all likelihood, have to let go of the zero brokerage structure and/or increase brokerage for F&O trades. Brokers across the industry will also have to tweak their pricing," said Kamath.

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