ICRA RESEARCH SERVICES

Financial Sector Ratings

ICRA RATING FEATURE
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Karthik Srinivasan
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INDIAN BROKERAGE INDUSTRY Vibha Batra

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vibha@icraindia.com

“Brokerage industry developing into a “winner takes all” market; Near Term outlook contingent on
outcome of the General Elections”

May 2014

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 INDIAN BROKERAGE INDUSTRY
Brokerage industry developing into a “winner takes all” market; Near Term outlook contingent on outcome of the ICRA RESEARCH SERVICES
General Elections May 2014
Executive Summary

Financial year FY14, was yet another difficult year for the domestic brokerage industry despite the pick-up in trading volumes in the latter half of the year. The rupee
volatility, current account deficit, fiscal deficit, persistent inflation along with perceived delays in policy formulation together contributed to erosion in investor confidence
in the Indian capital market for a major part of the year. However, perception of improvement in major macro-economic indicators buttressed expectations of the
economy bottoming out and led to an improvement in the global risk perception of India in the later part of the last fiscal. In anticipation of a stable national government
post elections in May 2014, the Q4FY14 FII inflows of USD 9.4 billion infused optimism in an otherwise lackluster year for the Indian capital markets. Not only did the
benchmark indices scale newer highs in March 2014 and continued their upward march in April 2014, even broader based mid-cap indices displayed a significant uptick in
Q4FY14.

At the industry level, Equity Average Daily Volumes (ADV) rose by ~22% to Rs. 511 trillion in FY14 buoyed by the continued rise in volumes of option trading, which
accounted for ~78% of the overall market volumes in FY14 (~76% in FY13). Despite the modest rise of 2% in FY14 after the last few years of steady decline, the proportion
of cash volumes to overall traded equity volumes continued to decline to 6.5% as compared to 7.8% in FY13. On the other hand, futures volumes rose by ~19% in FY14
while options volumes displayed a strong growth of 25% over the same period. Anecdotal evidence suggests that more and more non-institutional investors have been
taking a liking to trading in options. A broad based investor segment could ensure that the dominant share of options volumes to total equity volumes continues over the
medium term.

The institutional broking business faced significant headwinds in FY14 despite some improvement in the later part of the year following strong FII activity and successful
big-ticket divestments. Anecdotal evidence suggests that Foreign brokers have fared better than domestic institutional brokers and the better part of the incremental
institutional flows have accrued to foreign brokers. Consequently, the domestic institutional brokers’ share has slipped to ~25% while that of the foreign brokers has
strengthened to ~75% compared to the usual one-thirds and two-thirds share respectively in the past. Also, as a large proportion of incremental flows have been from
long-only funds, the penetration of Direct Market Access (DMAs) has stabilized at ~30-35% of overall volumes. ICRA notes signs of consolidation in the industry as many
small and mid-sized foreign brokers have cut down operations significantly. In ICRA’s view, as the cycle turns, large brokers who have withstood this test of the last few
years successfully may be better positioned to ride the possible upside.

On the retail equities side, the going remained tough as the retail participation was at multi-year lows for a large part of FY14. Post the strong FII inflows in Q4FY14, retail
volumes also saw traction and were higher by 5-25% in March - April 2014 as compared to the average of the rest of the year. However ICRA notes that the same
exuberance has not been seen consistently across retail brokers and the sustainability of this increase in retail participation remains a question. Three trends pertaining to
FY14 are worth highlighting. One, recognizing the downturn was more protracted than earlier estimated, ever rising costs of servicing customers, compliance costs as well
as connectivity costs in an environment seeing pressures on revenue is causing some of the larger standalone brokers to change their positioning and incrementally focus
on the affluent client segment from mass markets. To control costs, while the sales teams continue to be pruned down, the brick and mortar models (including franchisee
route) are now being consolidated. Smaller clients are being persuaded to go online as servicing them becomes increasingly unviable. However, while letting go of some

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 clients can be acceptable to larger brokers, the smaller brokers cannot afford any such luxury and continue to face challenges regarding their future. The second big change
was the emergence of online trading, which accounts for ~35-40% of retail volumes. As a result, discount brokers who have positioned themselves to provide a platform to
execute trades without significant research or back-end support but at a fraction of the cost have had a new lease of life. ICRA notes that these outfits are garnering market
share and creating a niche for themselves. Three, the banker-brokers continue to gain from strength to strength. While the rest of the industry has been going slow on
customer addition, banker-brokers have been adding clients aggressively. Aided by strong parent balance sheets and thus larger resources and a better grip on technology,
the banker-brokers have added to the competitive landscape. As a result, the industry continues to consolidate at a brisk pace with players exiting the markets rather than
a conventional Merger & Amalgamations route.

ICRA estimates, the overall equity brokerage revenue pool for FY14 to be in the range of Rs 96-98 bn, a marginal 1-2% growth over that for FY13. The underperformance of
the retail equity brokerage revenue pool may have been partially compensated by the performance of the institutional brokerage piece over the same period.

Commodities broking has been one of the brighter spots in the otherwise lacklustre performance of the Indian brokerage industry over the last 2-3 years. Lack of
competition from banker-brokers as well as foreign brokers as well as strong future prospects meant brokers had taken to commodities broking in an attempt to diversify
their revenue profile. However FY14 ended as one of the most disappointing years for commodities broking on account of the imposition of the Commodities Transaction
Tax (CTT) which took away a large chunk of jobber / arbitrageur volumes from the market and impacted liquidity. This combined with lower volatility in the commodity
prices coupled with the NSEL crisis and its fallout further impacted volumes, which then became a self-feeding phenomenon. Accordingly the ADV declined to Rs 102
trillion in FY14 compared to Rs 170 trillion in FY13 representing a decline of 40% on a Y-o-Y basis. Brokers responded by attempting to spur activity by compromising on
their yields which in ICRA’s estimation have declined to ~1.1-1.2 bps for 9MFY14 compared to ~1.3-1.4 bps in FY13. In ICRA’s estimation, the overall commodities broking
revenue pool declined by ~50-55% in FY14 to ~Rs 8-10 bn. Regulatory changes also impeded the growth of the currencies broking segment where volumes sharply
declined by ~50% in FY14 when compared to FY13 and we estimate that the currencies broking revenue pool may have dipped below Rs 1 bn.

ICRA has analyzed the financial performance of 15 prominent entities accounting for ~35% of the overall equity market share. For 9MFY14, the revenue growth has
remained flat (annualized) when compared to FY13 as the drop in the equity, commodities and currencies pool was somewhat compensated by higher market share for the
top brokers. However, in general standalone retail brokers have fared much worse than banker-brokers. The brokers continue to defend their costs and the cost-income
ratio has only seen a marginal rise to 81% for 9MFY14 as compared to 79% for FY13. Consequently, profitability indicators worsened for the brokerage companies.
Profitability as a percentage of total revenues declined to ~10% in 9MFY14 compared to ~11% in FY13. Return to assets also fell to ~1.4% in 9MFY14 compared to 2.1% in
FY13.

ICRA expects GDP growth to improve to 5.0-5.5% in FY15, factoring in a mild improvement in manufacturing growth and a pickup in investment activity in H2FY15. Other
critical parameters such as current account deficit, fiscal deficit and even inflation parameters have improved significantly for FY14 when compared to FY13. As the key
Indian macro-economic indicators display the initial signs of stability, all eyes remain on the outcome of the General Elections in May 2014. Brokers are largely unanimous
in their view that a stable government and subsequent policy action may go a long way in bringing back investor confidence and thus improving the investment climate.

The broking industry continues to steadily consolidate as some of the weaker players exit the business and the stronger players strengthen their position. The top 100
brokers account for ~80% market share as at March 2014 as compared to 77% as at March 2013. On the other hand, the industry has seen sub-broker attrition to the tune
of 20% of the base as at April 2013 in H1FY14. For the larger standalone brokers, improved retail participation may buy more time to find the correct business mix to

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 combat the structural changes in the industry and diversify even beyond the capital market business borders. However for the smaller brokers, unless there is a rapid
increase in retail participation, they will continue to face significantly higher pressures compared to their larger and more diversified peers. Thus the outcome of the
General Elections could potentially determine the pace of consolidation within the broking industry. Amongst the various categories of brokers, we believe that banker-
brokers are in a relatively better position to respond to the structural changes in the retail broking industry given the ability of the group to provide a composite product
offering to the clients while keeping costs under control.

1 2
This note covers the financials of 15 entities. However, for market share, brokerage revenue pool analysis, ICRA has used data for 13 prominent brokerage firms.

1
The 15 brokerage houses analyzed in the note are Angel Broking Limited, Bonanza Portfolio Limited, Edelweiss Financial Services Limited, Emkay Global Financial Services Limited,
Geojit BNP Paribas Limited, HDFC Securities Limited, ICICI Securities Limited, Indiabulls Securities Limited, India Infoline Limited, JM Financial Limited , Karvy Stock Broking Limited
Kotak Securities Limited, Motilal Oswal Financial Services Limited, Sharekhan Limited and Religare Securities Limited
2
For market share and revenue pool analysis, from the above mentioned list, data for ICICI Securities, J M Financial and Indiabulls Securities has not been used. Data for Anand Rathi
group however has been used.

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 This report includes an update on …

I. The equity markets in FY13-14 ………………………………………………………………………………………………………………………………………………………………………………………………………6

a. Trends in cash, futures and options volumes
b. Trends in market share for the top brokers
c. ICRA’s estimation of the equity brokerage revenue pool

II. The commodities markets in FY13-14…………………………….………………………………………………………………………………………………………………………………………………………………9

a. Trends in exchange traded volumes
b. Trends in mix of commodities traded to overall volumes
c. ICRA’s estimation of the commodities brokerage revenue pool

III. The currencies markets in FY13-14………………………………….……………………………………………………………………………………………………………..…………………………………………….12

a. Trends in exchange traded volumes
b. ICRA’s estimation of the currencies brokerage revenue pool

IV. Key Industry trends in FY13-14 ……………………..………………………………………………………………………………………………………….…………………………………………………………………14

a. Key trends to watch out for in the retail broking space
b. Key trends to watch out for in the institutional broking space

V. Financial performance for FY13-14 for 15 top brokers …………………………………………………………………………………………………………………………..………….……….……..…………19

VI. ICRA’s outlook for the Brokerage Sector for FY14-15……………………………………………………………………………………………………………………………………..….…………………………20

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