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KOLKATA Report on The Indian brokerage Industry

Submitted To:

Prof.Preethviraj Banerjee
Submitted By: Anishkumar

As any good work is incomplete without acknowledging the people who made it possible, this report is incomplete without thanking the people without whom this project wouldn't have taken shape. This project is a result of continuous cooperation, effective guidance and support from all the people associated with this project. We would like to express our regards and thanks to Prof. Prithavirajbanerjee, our mentor of Banking Systems, for giving us theopportunity to work on this project and learn something new. Weare indebted to him for clarifying our concepts by sharing hisvalued experience in teaching, research and training which havethereby become an unconscious part of our ideas and thoughtswhile analyzing the brokerage industry. A special thanks to the Almighty for giving us the opportunity and strength to complete this project. Lastly we would like to thank our families and friends for their continuing support, blessings and encouragement.

Executive Summary This report analyzes the Indian retail brokerage industry taking into account the health of thecapital markets and the intensity of competition among the brokerage companies. Michael Porter's Five Forces Analysis has been employed to present a picture to gain an understanding ofthe competitive landscape and industry attractiveness. It covers important segments of theindustry and analyses market dynamics. A differentiating aspect of this report is a comparative assessment of the top brokerages firms onvarious value indicators. The report also includes a comparative product grid of the companies under consideration. The major growth drivers for brokerage revenue and trading volume are: Continuous fall in brokerage fees Adoption of technology screen-based trading, electronic matching, and paperlesssecurities Centralized operations, effective risk management, and control on large interconnected operations spanning multiple locations, which is enabled by telecom connectivity and low costs Increasing access to capital and the ability to provide margin finance Though the Indian brokerage industry has been consolidating steadily over the last 10 years, theshare of the top 10 brokers has risen to only around one-fourth of the total industry revenues. Inthis fragmented market, leading players like ICICI Direct, Kotak Securities, Indiabulls,Sharekhan, and 5 Paisa, apart from many small players, compete on the basis of low brokeragefees and customer service. The major growth drivers of the Indian retail

brokerage industry are the increasing appetite forequities among investors as an asset class, the convenience of online trading, and decliningbrokerage fees OVERVIEW The Indian retail brokerage industry consists of companies that primarily act as agents for the buying and selling of securities (e.g. stocks, shares, and similar financial instruments) on a commission or transaction fee basis. It has two main interdependent segments: Primary market and the Secondary market. Evolution of the Indian Brokerage Market The Indian broking industry is one of the oldest trading industries that had been around even before the establishment of the BSE in 1875. Despite passing through a number of changes in the post liberalization period, the industry has found its way towards sustainable growth. The evolution of the brokerage market is explained in three phases: pre1990, 1990-2000, post 2000. Early Years The equity brokerage industry in India is one of the oldest in the Asia region. India had an active stock market for about 150 years that played a significant role in developing risk markets as also promoting enterprise and supporting the growth of industry. The roots of a stock market in India began in the 1860s during the American Civil War that led to a sudden surge in the demand for cotton from India resulting in setting up of a number of joint stock companies that issued securities to raise finance. This trend was akin to the rapid growth of securities markets in Europe and the North America in the background of expansion of railroads and exploration of natural resources and land development.

Bombay, at that time, was a major financial Centre having housed 31 banks, 20 insurance companies and 62 joint stock companies. In the aftermath of the crash, banks, on whose building steps share brokers used to gather to seek stock tips and share news, disallowed them to gather there, thus forcing them to find a place of their own, which later turned into the Dalal Street. A group of about 300 brokers formed the stock exchange in Jul 1875, which led to the formation of a trust in 1887 known as the Native Share and Stock Brokers Association. A unique feature of the stock market development in India was that that it was entirely driven by local enterprise, unlike the banks which during the pre-independence period were owned and run by the British. Following the establishment of the first stock exchange in Mumbai, other stock exchanges came into being in major cities in India, namely Ahmedabad (1894), Calcutta (1908), Madras (1937), Uttar Pradesh and Nagpur (1940) and Hyderabad (1944). The stock markets gained from surge and boom in several industries such as jute (1870s), tea (1880s and 1890s), coal (1904 and 1908) etc., at different points of time.

Beginning of a new equity culture A new phase in the Indian stock markets began in the 1970s, with the introduction of Foreign Exchange Regulation Act (FERA) that led to divestment of foreign equity by the multinational companies, which created a surge in retail investing. The early 1980s witnessed another surge in stock markets when major companies such as Reliance accessed equity markets for resource mobilization that evinced huge interest from retail investors. A new set of economic and financial sector reforms that began in the early 1990s gave further impetus to the growth of the stock markets in India. As a part of the reform process, it became

imperative to strengthen the role of the capital markets that could play an important role in efficient mobilization and allocation of financial resources to the real economy. Towards this end, several measures were taken to streamline the processes and systems including setting up an efficient market infrastructure to enable Indian finance to grow further and mature. The importance of an efficient micro market infrastructure came into focus following the incidence of market abuses in securities and banking markets in 1991 and 2001 that led to extensive investigations by two respective Joint Parliamentary Committees. The Securities and Exchange Board of India (SEBI), which was set up in 1988 as an Administrativearrangement was given statutory powers with the enactment of the SEBI Act, 1992. The broad objectives of the SEBI include yto protect the interests of the investors in securities yto promote the development of securities markets and to regulate the securities markets The scope and functioning of the SEBI has greatly expanded with the rapid growth of securities markets in India in the last fifteen years. Following the recommendations of the High Powered Study Group on Establishment of New Stock Exchanges, the National Stock Exchange of India (NSE) was promoted by financial institutions with an aim to provide access to investors all over the country. NSE was incorporated in Nov 1992 as a tax paying company, the first of such stock exchanges in India, since stock exchanges earlier were trusts, being run on no-profit basis. NSE was recognized as a stock exchange under the Securities Contracts (Regulations) Act 1956 in Apr 1993. It commenced operations in wholesale debt segment in Jun 1994 and capital market segment (equities) in Nov 1994. The setting up of the National Stock Exchange brought to Indian capital markets several innovations and modern practices and procedures such as nationwide trading network, electronic

trading, greater transparency in price discovery and process driven operations that had significant bearing on further growth of the stock markets in India. Faster and efficient securities settlement system is an important ingredient of a successful stock market. To speed the securities settlement process, The Depositories Act 1996 was passed that allowed for dematerialization (and dematerialization) of securities in depositories and the transfer of securities through electronic book entry. The National Securities Depository Limited (NSDL) set up by leading financial institutions, commenced operations in Oct 1996. Regulations governing selection of various types of market intermediaries as depository participations were made. Subsequently, Central Depository Services (India) Limited promoted by Bombay Stock Exchange and other financial institutions came into being.

Rapid Growth The last decade has been exceptionally good for the stock markets in India. In the back of wide ranging reforms in regulation and market practice as also the growing participation of foreign institutional investment, stock markets in India have showed phenomenal growth in the early1990s. The stock market capitalization in mid-2007 is nearly the same size as that of the gross domestic product as compared to about 25 percent of the latter in the early 2000s. Investor base continued to grow from domestic and international markets. The value of share trading witnessed a sharp jump too. Foreign institutional investment in Indian stock markets showed continuous rise reaching about USD10 bn in each of these years between FY04 to FY06. Stock markets became intensely technology and process driven, giving

little scope for manual intervention that has been the source of market abuse in the past. Electronic trading, digital certification, straight through processing, electronic contract notes, online broking have emerged as major trends in technology. Risk management became robust reducing the recurrence of payment defaults. Product expansion took place in a speedy manner. Indian equity markets now offer, in addition to trading in equities, opportunities in trading of derivatives in futures and options in index and stocks. ETFs are showing gradual growth. Within five years of introduction of derivatives, Indian stock markets now are ranked first in stock futures and fourth in index futures. Indian stock markets are transaction intensive and thus rank among the top five markets in this regard. Stock exchange reforms brought in professional management separating conflicts of interest between brokers as owners of the exchanges and traders/dealers. The demutualization and corporatization of all stock exchanges is nearing completion and the boards of the stock exchanges now have majority of independent directors. Foreign institutions took stake in Indias two leading domestic stock exchanges. While NYSE Group led consortium took stake in the National Stock Exchange, Deutsche Borse and Singapore Stock Exchange bought equity in the Bombay Stock Exchange Ltd.

Indian Brokerage Industry India in Global Markets

The stature and significance of India is growing in the world capital markets. India is not only attracting greater interest from world markets, but is also assuming increasing importance in global finance. yIndia is a major recipient of foreign institutional flows amongst the emerging markets. Since the opening up of domestic stock markets to foreign investors, cumulative net FII Investments reached Rs517Bn by 2008 end. yIndia is major destination of private equity flows into the emerging markets yIndia was host to the annual meetings/conference of the World Federation of Exchanges (2005) and International Organization of Securities Commission (IOSCO) (2007) yIndia emerged a trillion dollar market capitalization market in 2007, and was among the top 10 stock exchanges in the world in terms of market capitalization yIndia is amongst the top fifteen stock exchanges in the world in respect of equity turnover yIndia emerged as a leading player in commodities futures market yIndia is amongst the top five in the number of transactions yIndia is among the top five in respect of volume traded in Stock Index Futures and Stock Futures yIndia is one of the few markets with extensive dematerialization of shares yIndias T+2 securities settlement cycle is at par with the global standards yIndian stock markets have the largest number of listings, with trading taking place in about 2,500-3,000 stocks

yIndias most popular stock index (Sensex) is constructed on the basis of full float methodology, one of the firsts in the Asian region and a global standard yIndian market indices such as Sensex and CNX Nifty are listed in foreign exchanges for trading as ETFs. The year that was(2008) Secondary market trading volumes down 33% YoY FII outflows of ~USD 12 bn Nifty down ~36% Advisory transactions stable though some ground lost PE deals had fallen to almost half ECM activity down ~90% DCM relatively stable, though activity level were lower in second half of the FY08 due to liquidity crunch and counterparty fears Recent Trends (2009) Global risk aversion is unwinding and Confidence levels returning, being reflected in performance of the indices Liquidity and credit flows improving Political stability and India re-rating FII and Domestic Flows resuming, USD 7bn FII inflow in April & May Secondary volumes showing early signs of uptrend, average daily volumes of Rs800 bnvs. 620 bn in previous year Various important s measure taken by the Indian Government to improve the condition of Indian stock market. Measures Allow foreign institutional investors to invest in equity and debt markets Objective Liberalization of stock market to attract foreign investment in order Status yForeign investment up to 49% will be allowed in these companies with a

to boost economic growth

Expanding the product range offered by the stock exchanges

Bring Indian market at par with the international standards and diversify product portfolio.

separate FDI cap of 26% and FII cap of 23% after approval from FIPB yOutstanding limit for FII investment in debt securities raised from USD1.75 bn to USD2.0 bn and the same for the corporate debt raised from USD0.5 bn to USD1.5 bn SEBI approved new derivative products : mini-contracts on equity indices, options with longer life/tenure, volatility index and F&O contracts, Options on Futures, Bond Indices and F&O contracts, Exchange-Traded Currency (ForeignExchange) Futures and Options and Exchange Traded products to cater to different investment

Allowing Indian companies to issues ADRS and GDRS Allow Indian nationals and companies to invest abroad

Divestment of government Ownership Strengthening of institutional framework in primary and secondary markets Demutualization

strategies yFacilitate market yMutual funds were integration and give allowed to invest in freedom to the ADRs/GDRs and companies. foreign securities within the overall yAccess to more funds for investment limit of USD4 bn yVenture capital funds were allowed to invest in foreign securities yGuidelines on issue of Indian Depository Facilitate growth Providing minimum through privatization public shareholding of 25% in all listed companies yTo ensure ySEBI permitted transparency listed companies to yInvestor protection send yProvide a standard abridged annual report to the framework for shareholders operations yExclusive email ID yDeregulation to be given by the yReduces the primary market conflict intermediaries for of interest registering investor complaints yStock exchanges advised to update

the applicable VAR margin rates at least five times in a day ySEBI approved and notified the Corporatization and Demutualization Schemes of 19 stock exchanges

1. Macro-Economic Scenario The Indian economy, which witnessed robust growth up to the second quarter of FY09, recorded sharp deceleration thereafter in the wake of persistent global economic slowdown. India's real GDP grew 6.7% during Financial Year (FY) 09 as compared with 9% during the corresponding period of FY08. Though India's growth trajectory has been impacted both by the financial crisis and the global economic downturn, the structural drivers of the Indian economy continue to be intact, sustaining overall growth at a level much higher than most other economies in the world.
2. Capital Markets Index Movement The BSE Sensex saw an unprecedented swing in Calendar Year (CY) 08 - from 20,873 in January 2008 to 8,451 in November 2008. The key negatives that drove down Indian markets were weakness in global financial markets, slowdown in the domestic economy, tight monetary policy in 1 HFY09, and heavy selling by Foreign Institutional Investors (FII). All these factors contributed to a series of large downgrades in corporate sector earnings. Another highlight of FY09 has been a 27% depreciation in the Indian rupee v/s the US dollar, which has also had a negative impact on earnings.

FII & MF Activity in Equity Markets FY09 was the first fiscal in India's history when FIIs were net sellers in Indian equities; secondary market FII outflows for the year were Rs. 479 billion. Interestingly, FY08 was the year of record net FII inflows of Rs. 517 billion. However, mutual funds continued to be net buyers for the sixth consecutive year. In FY09, mutual funds were net buyers to the tune of Rs. 66 billion, which is a 52% drop from Rs. 137 billion of net buying in FY08.

3. Broking Industry Equity Market Volumes: The average daily equity market volumes for FY09 were Rs. 612 billion, down 16% from Rs. 726 billion in FY08. However, during the six years beginning FY03, the year when cash and derivatives were fully active on both the exchanges, total market volumes have grown by 50% compounded annually. During this period, volumes in the derivatives and cash segments have grown at a compounded annual growth rate (CAGR) of 72% and 27%, respectively. The notabletrends in customer segmental volume mix that influence market volumes are as follows: 1. The contribution of retail volumes has declined from 61% in FY08 to 55% FY09; the retail contribution ratio has been more volatile than the other two market segments. 2. The contribution of institutional volumes, i.e. volumes from FII and domestic institutional investors (DIIs) such as mutual funds, banks and insurance companies has remained stable at 15% for FY08 and FY09. 3. The contribution of proprietary volumes, which include arbitrage and other proprietary volumes of stock brokers, has increased from 24% in FY08 to 30% in FY09.

Growth in average daily volumes on the NSE & BSE from FY03 to FY09 (Rupees in billions

Source: NSE & BSE Segmental mix of total volumes (NSE & BSE combined

Source: NSE & BSE Demat Accounts Increasing Equity penetration by growth in demat accounts (in millions)

Source: CDSL & NSDL Note: 1. Number of demat accounts in million 2. FY09 figure includes figures of NSDL as on 31 March 2009 and figures of CDSL as on 28

February 2009 3. All the above numbers indicate active accounts except of CDSL for the period between FY00 to FY05, which are total number of demat accounts with CDSL .The number of demat accounts in the country shows the depth of equity penetration. CDSL and NSDL together have over 15 million active demat accounts. 4. Investment Banking M&A and Private Equity The CY 2008 saw a decline in total deal activity in terms of volume and value of deals both in the Mergers and Acquisitions (M&A) and Private Equity (PE) space. However, the volume andvalue of deals for both M&A and PE were higher in CY08 than in CY06. Also, the average deal size for both M&A and PE was larger in CY08 than in CY06. The key highlights of the deal activity are as follows: 1. The total value of deals (M&A and PE) announced during CY08 was US$42 billion 2. The average deal size during the year was US$68.17 million for M&A and US$33.93 million for PE 3. There were 766 deals (M&A and PE) during CY08 Value of different types of deals during CY06, CY07 and CY08 (Rupees billion) Source: Grant Thornton Deal Tracker 2008 Fund raising activity by companies: Corporate India raised Rs. 3.21 trillion in CY08 through debt and syndicated loans and offerings in equity capital markets - a 19% drop in the amount raised compared to the Rs. 3.96 trillion in CY07.

Debt & Syndicated loans 2008 - Size Rs. 2657 billion

Equity Capital Markets 2008 - Size Rs.549 billion Source: Bloomberg League

Tables, Prime database, internal calculations. Indian companies raised equity of Rs. 549 billion in CY08 through IPOs, QIPs, additionalofferings and rights issues and other equity offerings - a decrease of 48% compared to CY07. A total of 34 companies raised funds through IPOs in the domestic stock markets in CY08amounting to Rs. 183 billion - a 46% drop compared to the Rs. 338 billion raised from 89 IPOsin CY07. The proceeds from rights offerings increased significantly from Rs. 80 billion in CY07 to Rs. 297 billion in CY08. This accounts for 54% of the total funds raised in domestic equity capital markets in CY08. Market Size and Characteristics Markets In tune with the global stock markets that began to recover from the second half of 2003; Indian stock markets too witnessed rapid growth. Indias two leading indices, the most popular BSE Sensex, and the one most used by the markets the National Stock Exchanges S&P CNX Nifty rose to record levels. Both primary and secondary market activity experienced sharp surge. Much progress was made in further strengthening and streamlining risk management, market regulation and supervision. A few aspects of the major developments in the Indias stock markets are described below. 1. Market Structure

Indian securities market is fairly large as compared to several other emerging markets. Institutional Structure of the Indian Stock market.

Market Intermediaries2008 Stock Exchanges(Cash Market) 19 Stock Exchanges(DerivativesMarket) Brokers(Cash Segment) 9487 Corporate Brokers (Cash Segment) 4190 Sub-brokers (Cash Segment) 44074 Brokers(Derivatives) 1442 Foreign Institutional Investors1319 Custodians 15 Depositories 2 Depository Participants654 Merchant Bankers 155 Bankers to an Issue50 Underwriters35 Debenture Trustees28 Credit Rating agencies Venture Capital Funds 106 Foreign Venture Capital Investors97 Registrars to an Issue &Share transfer Agents Portfolio Managers205 76 5 2

Mutual Funds40 Collective Investment Schemes0

Source: SEBI statistics handbook 2008