Why don’t Indian stock brokers follow the US 0% brokerage model?

In October 2019, when some major stock brokerage firms in the United States introduced commission-free platforms, it created a buzz on Dalal Street in India and among investors who thought Indian brokerage firms would follow suit as well. But that wasn’t going to happen.

Nithin Kamath, founder of India’s largest equity brokerage, Zerodha, commented and explained on Twitter why India cannot follow the US model of zero percent brokerage on trading.

Why did US brokerages go for zero?

Several US brokerage firms with billions of dollars in brokerage revenue have decided to adopt the no-brokerage business model from the beginning of 2018. The US stock market is much older than the Indian market and therefore very different as well. Subtle differences such as handling client trades versus off-market stock exchanges, client fund holdings and other related work are handled differently. Due to these differences in process management, US brokerages could opt to charge zero brokerage fees on trades.

What are the differences?

1. Client’s fund holdings in cash

In India, the capital market regulator, the Securities and Exchange Board of India (Sebi), has required that all securities brokers registered with various Indian stock exchanges must return all unused funds kept in their trading account. customer once a quarter. If a stockbroker fails to refund the client’s unused cash due to a specific rule or exemption, the broker will need to issue a “withholding statement” and explain why the refund was not made.

The United States has no such rule, and therefore stockbrokers are free to use their clients’ idle cash balance to earn notional interest income if they choose. But if clients demand that their money be returned to them, the brokerage must comply.

2. Payments for order flow

In India, it is mandatory that anyone wishing to trade securities on the stock exchange can only do so through a registered stockbroker or a recognized stock exchange. The web interface or direct market access portal shall be provided by the broker upon client’s request or by any predefined agreement. Each order must be sent to the recognized stock exchange indicated and nowhere else.

“In India, all orders placed on a broker’s trading platform are sent to exchanges in real time for matching and execution. Exchanges here earn by charging transaction fees on such orders. United States, an exchange’s main source of income is from selling data feeds,” Kamath said in his tweet.

In India, brokerage changes are usually 0.01-0.1% or a flat fee per trade of 15-20 rupees.

The United States Securities and Exchange Commission (SEC) has required that the price at which the client would buy a stock be the same as the National Best Bid and Best Offer (NBBO), but the order may or may not be sent to exchanges. . So what most brokers who follow the zero percent brokerage model have done is they have sold their clients’ order data to other hedge funds and high-end trading firms. frequency for millions of dollars. This is not legal in India.

3. Holding of Securities

In India, exchange-traded securities are held in depository accounts maintained by two depositories – National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL), which are independent of the operation of a securities broker and the stock Exchange. In the United States, client securities are kept in a system of “books and records” which is maintained by the brokers themselves. So while US brokers can lend these securities freely and earn interest income, Indian brokers cannot do so with retail securities. In India, there is a securities lending and borrowing protocol, which retail investors can avail themselves of, but they must participate voluntarily, unlike in the United States.

“In India, brokers cannot lend securities as these are deposited in clients’ demat accounts with custodians. (However) India has a SLB (Stock Lending and Borrowing) platform where clients can participate directly,” Kamath said in his tweet.

All of these additional revenue streams allow US brokers like Charles Schwab, TD Ameritrade, and Robinhood to charge zero brokerage on trades. The Indian stock market is relatively new compared to the US market. As trading volume increases and more people participate in the stock markets, we can expect brokerage fees to decrease in the future.

Dolores W. Simon