ICRA INDUSTRY UPDATE

EQUITY BROKERAGE INDUSTRY

Profitability improves in Q2-FY10 over the previous quarter aided
by revival in capital market sentiments…

Analyst Contact: Industry Outlook: Neutral

Karthik Srinivasan
karthiks@icraindia.com ICRA has noted the improvement in profitability indicators
+91-22-3047 0028 during Q2F09-10 for most players in the segment. However,
ICRA continues to maintain a neutral outlook on domestic
Vikas Garg brokerage houses on account of inherent volatility in the
vikasg@icraindia.com capital markets and also on account of uncertainty on the
+91-22-3047-0024 outcome of various impending structural changes in the
industry which could have mixed implications for Brokerage
Ravi Mittal
Houses.
ravim@icraindia.com
+91-22-3047-0036

Industry Update: Q2FY09-10

November 2009
Operating environment further improves in second quarter of
FY09-10...
Equity broking turnover at National Stock Exchange (NSE) and
Bombay Stock Exchange (BSE), combined, reported a 10%
rise in Q2FY09-10 on sequential quarter on quarter basis and
35% rise on year on year basis largely driven by sharp
increase in volumes in option trading.
Overall average equity brokerage yields may have declined
with larger proportion of option trading volumes; likely to
remain intact for respective segments namely cash, futures
and options.
Big initial public offerings (IPO) during the quarter added to the
revenues.
Margin funding and IPO funding business pick up again with
improvement in market sentiments. Lower cost of funds also
adds support.
Various cost cutting measures undertaken during the earlier
quarters help keep the operating expenses under control.

Website:
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 ICRA Industry Update Brokerage Houses

Equity brokerage turnover continues its upward journey; led largely by options segment…

Source: NSE Website Source: NSE Website

During Q2FY09-10, equity broking turnover increased by 10% on sequential quarter basis (35% on
year on year basis). The growth was largely fuelled by the rise in volumes in the options segment,
which reported a 35% jump on sequential quarter basis and 74% jump on year on year basis. On the
other hand, Cash segment and the Future segment reported negligible growth in Q2FY09-10 on
sequential quarter basis and 37% and 11% growth respectively on year on year basis. In-fact, trading
volumes in the Options segment has been on an increasing trend since FY08-09 and accordingly, the
option trading volumes accounted for 35% of the total trading volumes in the exchanges in Q2FY09-
10 from less than 10% during FY07-08.

While the equity broking volumes have increased during the Q2FY09-10, a similar growth his not
reflected in the equity broking revenues of the brokerage houses on account of lower average
brokerage yields on option trades. On an average, yield on trading in options is 1 – 2 basis points
while it is 3 – 4 basis points in the future segment and as high as 10 – 12 basis points in the cash
segment. Accordingly, ICRA believes the average brokerage yield to have declined in Q2FY09-10,
however, average yields in the respective segment may not have declined significantly during the
quarter.

Lending activities pick up again, though on a smaller scale; IPO funding provides support…
Lending against liquid securities
(margin funding and loan against
shares) picked up again in the quarter
after a steep decline during the
previous financial year. While the
increasing trend in the equity prices
drove the demand for funding (from
investors), brokerage houses were
also more willing to lend, thanks to the
easing liquidity and improving
operating environment. The same is
reflected in the increasing funding
1
portfolio of the brokerage houses
especially during the last quarter.
However, the portfolio size still
remains relatively low as compared
with the peak levels seen in FY07-08.

Source: ICRA data base1

1
Data compiled for Rathi Global Finance Ltd, ECL Finance Ltd, IL&FS Financial Services Ltd, India Infoline
Investment Services Ltd, Birla Global Finance Company Ltd, Religare Finvest Ltd, Investsmart Financial Services
Ltd, Motilal Oswal Financial Services Ltd, IDFC, JM Financial Product Pvt Ltd, Deutsche Investments India
Private Ltd, Kotak Mahindra Investment Ltd, Kotak Mahindra Prime Ltd and Emkay Global Finance Ltd.

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ICRA Industry Update Brokerage Houses

Going forward, in ICRA’s view, loan against securities activity may pick up at a quicker pace on
account of lower incremental concerns on economy. Nevertheless, ICRA expects the size of lending
against securities portfolio to remain volatile owing to its linkage with the capital market.

During FY09-10, many large ticket

IPOs hit the capital market in the back
of improving operating environment.
Domestic capital market has already
seen 15 IPOs in the current financial
year (till October 2009) with an overall
mobilization of ~Rs 150 billion as
compared with Rs 20 billion mobilized
by 18 IPOs in the entire FY08-09.
While the addition of new stocks adds
to brokerage volumes, new IPOs also
help the brokerage houses in earning
distribution income and advisory fees.
In addition, they also provide a quick
revenue source for the NBFCs in
terms of the IPO funding.

Source: NSE Website

In ICRA estimates, total IPO funding done by the financiers in Q2FY09-10 for big IPOs like NHPC Ltd,
Adani Power Ltd, Oil India Ltd and Pipavav Shipyard Ltd was in the range of Rs 330 – 340 billion.
With the lenders maintaining a interest spread of 3-4% on ~15 days funding, they would have earned
additional net interest income of Rs 0.35 – 0.55 billion during the quarter.

Table 1: Big IPOs during H1FY09-10 and estimated IPO funding for them
IPO name IPO Size (band) Amount No of times Estimated IPO
Rs billion mobilized in HNI IPO subscribed funding Amount
segment Rs in HNI segment
billion
NHPC Limited Rs 50 – 60 billion Rs 302 billion 56 Rs 287 billion
Adani Power Ltd Rs 27 – 30 billion Rs 23 billion 8 Rs 20 billion
Oil India Ltd Rs 25 – 28 billion Rs 25 billion 10 Rs 22 billion
Pipavav Shipyard Ltd Rs 4.7 – 5.1 Rs 7 billon 14 Rs 6 billion
billion
Total Rs 335 billion
Note: amount mobilized in HNI segment is assumed at median of price band. Data based on ICRA estimates.

However, going forward, the profitability of IPO funding programme could get impacted by the RBI’s
2
draft proposal to ban Non Convertible Debentures (NCD) of less than 90 days maturity . If the
proposal is implemented, brokerage houses will not be able to issue short term NCDs for their IPO
funding programme and they would have to tap the relatively more expensive and regulated
Commercial Paper market. In ICRA’s view, while the new proposal of RBI, if implemented, could
increase the cost of funds for the brokerage houses, they would still continue with their IPO funding
programme on account of favourable risk-adjusted returns for these companies in the IPO funding
product. GoI’s plans of diluting its stakes in various public sector companies will also add to the IPO
funding programme in a big way.

2
Made in the Credit Policy of October 2009

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3
Broking network scales up at a rapid pace; led by the franchisee route…
Brokerage houses rapidly scaled up their
branch network in H1FY09-10, as compared
with the FY08-09, buoyed by the improvement
in market sentiments in the FY09-10. The
branch expansion was largely driven by the
addition of new franchisee as the brokerage
houses remained cautious on adding company
owned branches in order to keep costs low.
Over past few years most of the brokerage
houses have been expanding their branch
network through franchisee route in order to
gain market share while keeping a flexible cost
structure. Going forward also, brokerage
houses have chalked out aggressive
expansion plans. Earlier in H2FY08-09, most
of the brokerage houses had put their
expansion plans on hold with few of them also
consolidating the branch network. Source: ICRA database3
4
Profitability improves in Q2FY09-10…
Financial profitability of the brokerage houses
improved further during Q2FY09-10 from the
previous quarter on account of rise in income
and control on operating expenses. While the
brokerage income reported a marginal growth
during the quarter, higher income from non-
broking operations and fund based operations
was the growth driving factor. Accordingly, total
2
income of eight listed brokerage houses in
Q2FY09-10 saw a 19% rise on quarter on
quarter basis and a 17% rise on year on year
basis.

Operating expenses of the brokerage houses Source: BSE website. ICRA database4
remained under control during the quarter on
account of various cost cutting measures
undertaken by the companies in the previous
quarters. In ICRA’s view, low incremental
credit provisioning requirement would have
also led to lower operating expenses.
However, as expected by ICRA, while
brokerage houses improved upon their cost to
income ratio during the quarter, it continued to
remain inferior to that in FY07-08. With the
improvement in the operating environment,
brokerage houses have once again started
scaling up their branch network and fresh
recruitment. However, the focus is more on
maintaining high proportion of variable
expense so as to keep the operating expenses
flexible.
Source: BSE website. ICRA database4
3
Data compiled for seven brokerage houses namely India Infoline Ltd, Motilal Oswal Financial Services Ltd,
Edelweiss Capital Ltd, Emkay Global Financial Services Ltd, Religare Enterprise Ltd, Kotak Securities Ltd and
Sharekhan Ltd.
4
Data compiled for eight listed brokerage houses namely India Infoline Ltd, Motilal Oswal Financial Services Ltd,
Edelweiss Capital Ltd, Indiabulls Securities Services Ltd, Emkay Global Financial Services Ltd, HSBC
Investdirect (India) Ltd, Geojit BNP Paribas Financial Services Ltd and Religare Enterprise Ltd.

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ICRA Industry Update Brokerage Houses

Short term profitability expected to remain comfortable despite pressures on distribution

income…
In the last few years, the brokerage houses were focused on diversifying their operations by
strengthening their distribution business largely on selling the third party mutual fund products and
insurance products. While the associated incremental cost was low as brokerage houses’ leveraged
upon the existing branch network, it helped in reducing their dependence on the more volatile equity
broking business.

However, few of the regulations already implemented by the regulators and others in the pipeline
could impact the revenue stream for the brokerage houses. Recently, SEBI has already abolished the
entry load on mutual fund schemes which is expected to impact the fee income of brokerage houses
from the distribution of mutual fund products. Another proposal to cap the commission for the
distributors of insurance products could further impact the distribution income. Although some of the
brokerage houses have already aligned their distribution business model in terms of moving from
commission based revenues from the Asset Management Company / Insurer to advisory fees from
the client, its effectiveness is yet to be demonstrated.

While brokerage houses could witness some pressure on their distribution income, ICRA expects the
overall profitability of the brokerage houses to remain comfortable in the short term assuming no
further negative surprises in the global and domestic market, easing of liquidity & credit concerns and
improving of market sentiments. Many companies proposed fund raising plans through IPOs and QIP
in better market sentiments will also add to the turnover velocity in the equity market.

Impact of the proposed structural changes yet to be seen…

In medium to long term, profitability of the brokerage houses is expected to depend more on the
various structural changes proposed by the regulators recently which are expected to have mixed
implications for the brokerage houses. Few of the recent regulatory proposals are as follows:-

 Longer trading hours permitted at the Exchange Houses…

Market regulator SEBI has proposed to allow Stock Exchanges for longer trading hours from 9 a.m to
5 p.m as against 9.55 a.m to 3.30 p.m currently which would result in overlapping of the domestic
market with Asian market in the morning hours and European market in the evening hours. While this
move is expected to increase the equity turnover it could also result in higher market volatility as the
domestic capital gets exposed to the vagaries of the overseas markets. Higher volatility could lead to
higher margin requirement at the Exchange Houses thus the increase in working capital requirement
for the Brokerage Houses. Extension of market hours could also increase the implied volatility thereby
making the options and future contracts costlier which in turn could impact the trading volumes. ICRA
would closely monitor the impact of the longer trading hours on industry trading volumes once the
Exchange Houses extend the trading hours.

 SME listing norms finalized…

SEBI had also been considering an Alternative Exchange dedicated to Small and Medium Enterprises
and also relaxing the listing standards for SMEs for quite some time. While SEBI has not permitted an
alternative Exchange House for the listing of SMEs, it has allowed a separate SME platform on
existing nationalised exchanges. SEBI has finalized the listing norms of SMEs with a minimum paid
up capital requirement of Rs 100 million and capped at Rs 250 million and a minimum trading lot of Rs
0.1 million. However, merchant bankers will be required to ensure that 100% of the SME’s IPO is
underwritten with minimum 15% to be underwritten by the lead banker. While the listing of SMEs
could open new avenues for the merchant bankers, 100% underwriting requirements and small ticket
size could see less number of the merchant bankers active in this space.

 Regulators allow trading in more pairs of currency futures…

RBI has proposed to permit currency futures contracts in currency pairs of Euro-INR, Japanese Yen-
INR and Pound Sterling-INR, in addition to US dollar-rupee contracts, which was allowed earlier in
August 2008. The combined average daily turnover of the USD – INR contracts in all the three
exchanges has increased from US$ 1.1 billion in March 2009 to US$ 2.5 billion in September 2009
and introduction of new currency pairs will add to the overall volumes.

 Other financial sector reforms also proposed…

RBI has proposed to ban Non Convertible Debentures (NCD) of less than 90 days maturity and also
to bring the short term NCDs under the SEBI’s regulatory purview which is expected to increase the
cost of funds for the brokerage houses, at least for their short term funding activities. Recent “Pure

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ICRA Industry Update Brokerage Houses

Auction Method” proposed by SEBI for IPO pricing could impact the subscription level in Qualified
Institutional Buyers (QIB) category and thus the subscription level in HNI and retail category also
which takes cue from the QIB segment. Lower subscription levels would result in lower IPO
distribution income for the brokerage houses and also lesser opportunities of IPO funding to the HNIs.
Another proposal to increase the minimum ticket size for Portfolio Management Services to Rs 2.5
million will further impact the revenue profile of the brokerage houses.

In ICRA’s view, while the regulators have proposed / implemented various measures that could
impact the overall profitability of the brokerage houses, other financial sector reforms introduced by
the regulators would add new trading segments which would help the brokers diversify their product
portfolio. In ICRA’s view, established brokerage houses with large geographic penetration & client
base would be better placed to capitalize upon new opportunities while keeping the incremental
expenses low. Nevertheless, ICRA expects the equity broking to continue to remain a dominant
segment on account of higher average brokerage yield as compared to other asset classes and long
gestation time for trading volume in new segments to achieve a sizeable volume.

Conclusion
While ICRA has noted the improvement in profitability indicators during Q2F09-10 for most players in
the segment, ICRA continues to maintain a neutral outlook on domestic brokerage houses on account
of inherent volatility in the capital markets and also with the uncertainty on the outcome of various
impending structural changes in the industry which could have mixed implications on profitability of
the brokerage houses. Even though the market turmoil seems to have eased out somewhat and
industry broking turnover has witnessed an upward movement in FY09-10, ICRA expects the market
volatility to continue for a while both in terms of equity prices and turnover. Further, recent guidelines
on mutual funds and insurance industry (proposed) would only increase the brokerage house’s
dependence on broking business. While the new asset classes added to the exchange traded
platform would provide diversity to the trading volumes, scalability in these business segments will
take time.

November 2009

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ICRA Industry Update Brokerage Houses

Annexure 1: ICRA rated entities engaged in capital market related business

operations

Sr. No Company Rating

1 Anand Rathi Commodities Limited A2+ (SO)
2 Anand Rathi Financial Securities Limited LA-/ A2+
3 Anand Rathi Stock & Shares Brokers Limited LA-/ A2+
4 Birla Global Finance Company Limited A1+
5 Bonanza Commodity Limited A2
6 Bonanza Portfolio Limited A2
7 CD Integrated Services Limited A3+
8 Crosseas Capital Services Private Limited A4+
9 Dalmia Securities Private Limited A1
10 Dimensional Securities Private Limited LBBB- / A3
11 ECL Finance Limited A1+
12 Edelweiss Capital Limited LAA-
13 Emkay Global Services Limited A2+
14 Enam Securities Private Limited A1+
15 Enam Finance Private Limited A1+(SO)
16 Gupta Securities Limited LBB+/ A4+
17 IDFC-SSKI Securities Private Limited A1+
18 IL&FS Financial Services Limited A1+
19 India Infoline Investment Services Limited LA+ / A1+
20 India Infoline Limited LAA-/ A1+
21 Infinity.com Financial Securities Limited A3
22 Intime Spectrum Securities Limited LBBB-/ A3
23 Investsmart Financial Services Limited A1+
24 Joindre Capital Services Limited LBBB- / A3
25 KIFS Securities Private Limited A2+
26 Kotak Mahindra Investments Limited LAA -/ A1+
27 Kotak Securities Limited LAA / A1+
28 Nirmal Bang Securities Limited LBBB/ A2
29 Pashupati Capital Services Private Limited LBBB- / A3
30 Pioneer Investcorp Limited LBBB- / A3
31 Prabhudas Lilladher Financial Services Limited A1
32 Reliance Securities Limited A1+ (SO)
33 Religare Finvest Limited A1+
34 Sharekhan Limited A1+
35 Shilpa Stock Brokers Limited LBB+/ A4+
36 Standard Chartered - STCI Capital Markets Limited (formerly UTI A1+
Securities)
37 Sushil Financial Services Private Limited A4+
38 Sykes & Ray Equities (India) Limited A3
39 TransGlobal Securities Limited LBBB-/ A3

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ICRA Industry Update Brokerage Houses

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