Fight for flight for Indian broking

These seem to be the only options left for a beleaguered Indian broking industry that is under attack from its technologically stronger global rivals Other conditions being equal, if one force is hurled against another 10 times its size, the result will be the flight of the former,” says the ancient Chinese philosopher Sun Tzu in his classic military treatise The Art of War. This is as true on the battlefield as it is in the stock market, as many Indian brokers facing the brunt of bigger and technologically advanced rivals will likely agree. Confronted with contracting margins and declining profits, they are fighting the mother of all survival battles. A few have even shut shop.

Alchemy Shares and Stock Brokers is a case in point. For the 40-odd employees working in the firm owned by Alchemy Capital, June 27 began like any other day. They went about their business, took the usual coffee breaks and indulged in idle chat. But all that changed when Lashit Sanghvi, co-promoter of the firm, called the employees into his office and told them that he was shutting down their division. He gave them their June salary and a severance package. Sanghvi’s was not a rash decision. For a while he tried to get an international buyer, but when no deal materialised he knew it was closing time.

Nor is it an isolated case. In the same week, the promoter of another mid-size institutional broking firm asked its employees to take a 60 percent pay cut. This was unacceptable to the head of the division, who walked out with his entire team.

Over the past two months, many Indian brokers with institutional arms have tried to sell out to foreign brokers looking to set up shop in the country. In fact, a well-known investment banker is still looking for a buyer for three Indian brokerages and is in talks with some foreign brokerages.
Alchemy Capital was never a big firm but it wasn’t insignificant either. One of its promoters is billionaire investor Rakesh Jhunjhunwala. It’s only because Jhunjhunwala is a promoter that many investors bought the firm’s investment advice. Of course, all of this came to naught with Alchemy’s fight for survival.

For many, Alchemy’s fate is indicative of a deeper malaise in the Indian broking industry. Foreign brokerages with their superior technology and global presence are starting to get a choke-hold on their Indian rivals. If Indian broking houses were to write a research report on their own sector it would probably be titled ‘Sector Underweight’!

A major reason for their undoing lies in a little known formula that sits inside computers and helps in smoothening trade but is generally ignored by Indian brokers. It is known as Direct Market Access (DMA) and is slowly becoming the backbone technology for trades. Most Indian broking firms are just beginning to adapt to this technology, which is a precursor to algorithmic trading (see Forbes India September 20, 2010).

This technology has brought down commission revenues for brokers from 20 basis points to about 8 basis points in a single year. The effect on the finances of Indian brokers is visible. Over the past three years, revenues for listed Indian brokerages have fallen 3 percent, while profits have shrunk 26 percent. To make matters worse, expenses are rising sharply due to increasing salaries and technology investments.

“As in any other market, technology will be the biggest differentiator in the Indian market and it will be challenging for Indian brokers, who are relatively new to trading technology, to compete with the international players that have been in this business for a long time. In this scenario, Indian brokers will partner with foreign players and work like a sub-broker. At the same time, Indian brokers’ local expertise and knowledge will be valuable for the foreign partner,” says Murat Atamar, head of the Credit Suisse’s advanced execution services product for Asia Pacific. Switzerland-based Credit Suisse is one of the market leaders in institutional broking in India.

Statistics clearly show that consolidation is on its way. In 1999-2000, the top 100 brokers accounted for 49 percent of the total turnover on the NSE. In 2009-10, this rose to 73 percent and in the next 10 years, they are expected to account for 80 percent of the turnover. On the institutional side, which accounts for 30 percent of the total turnover, 10 brokers account for 80 percent of the trade. Almost all are foreigners.