New SEBI rule putting pressure on brokerage firm charges

From October 7, a new SEBI rule kicked in. The rule states that every broker has to transfer all unused funds lying with their clients on the first Friday of every month or quarter, based on the client’s preference. This move is expected to increase brokerage costs since brokers will have to use their own capital to execute trades the following Monday.

What are Stock Brokerage Charges?

Brokers are middlemen who help execute transactions such as the buying and selling of stocks on behalf of their clients. In return for this, they charge a brokerage commission. 

Brokerage fees are commonly charged as a flat fee, as a percentage of the transaction executed or a combination of both. The amount of fees, however, varies between brokers. For instance, full-service brokers charge higher fees as they provide a specialized suite of services compared to discount brokers.

How is the new rule different?

Usually, investors open an account with a brokerage firm of choice and deposit their funds – like a digital wallet. From this wallet, the broker can place trades on behalf of the investor. It is not necessary that all funds will be utilized by the broker and most often there will be cash sitting in the wallet. And that’s where SEBI’s new rule comes in. 

The transfer of unutilized funds used to take place on the first Friday of every quarter. Under the new rule, clients will now have the option of choosing either the first Friday of every month or first Friday of every quarter – as per their convenience. The rationale behind this is to ensure that the funds are not being misused.

Why aren’t brokerage firms a big fan of this move?

Say all clients of a firm ‘X’ have opted for a monthly transfer of balances. Now, if it transfers all unused money on Friday and wants to execute a contract on the coming Monday, X needs to use his own money or wait until the client sends money – which could be a while. Mostly, the firm will end up using its own funds to trade on client’s behalf so that profits aren’t lost.

Brokers face three major issues here:

1. Sending large amounts in a single day can cause operational risks.

2. The requirement of working capital is higher especially on the Monday, after the Friday’s account settlement.

3. A hit on their floating income (interest income)

As a result of the hit on their income, brokers might increase their rates over time as they will have to borrow to meet their working capital needs and complete trades on the subsequent Monday.

Is 0% brokerage a distant dream?

In India, brokerage charges are usually 0.01-0.1 % or a flat fee per trade of Rs 15-20. This may look like a small number but as your portfolio size increases, every % will hit your profitability.

In USA, there are many firms that offer a 0% brokerage trading model. How? Well, its system provides many alternative ways of earning revenues from a client. However, in India, the options are restricted to cross-selling and the traditional flat fees/percentages.

For instance, in most countries, brokerage firms are free to use their client’s idle cash balance to meet their working capital needs as well as earn some interest income – until clients demand them back. As we saw, this isn’t possible in India as the funds can only be used for customer trades. Another difference is that brokers in India can’t lend securities as they are held with depositories which are independent of a stockbroker. On the other hand, US stockbrokers can freely lend these securities and earn an interest income since client securities are held with stockbrokers themselves.

Moreover, the Indian Stock Market is newer compared to other developed stock markets. It is a volume game and with more participation in the stock market, we can expect a drop in such costs. But for now, 0% brokerage is a distant dream as brokerage firms need these cash flows to sustain themselves.