Hollow and skewed stock market: 

After retail, now institutional broking is hit. While broking companies suffer, the two major exchanges and the regulator are making money hand over fist ...

Moneylife Digital Team

Rakesh Jhunjhunwala-supported Alchemy Shares and Stock Brokers is closing down its institutional broking arm due to poor growth in the business. There are also reports that India Infoline (IIFL) is considering to demerge its institutional broking arm. Interestingly, IIFL had got into the institutional broking business with great fanfare in 2007. It poached Bharat Parajia, Nem Kumar, Aniruddha Dange and Vasudev Jaganath, who were members of the core investment team at CLSA (Credit Lyonnais Securities Asia) for a package never heard of in the industry. 

The institutional broking segment of the broking business deals mainly with orders of large institutions such as foreign and domestic institutional investors. Why is the business doing badly despite the fact that fund inflows from foreign institutional investors totalled almost $30 billion in 2010? 

Well, it is part of the story that we have been highlighting for some years now: The Indian market is hollow and skewed. We have documented that retail investors have deserted the stock market despite the long bull market-thanks to irritating rules, ever-changing policies, malpractices by some stockbrokers, and so on. Now, after the business from retail investors has dwindled, the business from institutional investors is also turning out to be unprofitable, especially for Indian firms. 

The margin in the institutional broking business is lower than that in the retail business and expenses are very heavy. This is supposed to be made up by high trading volumes. Brokerage firms look for highly experienced staff that can pull in business from global firms. But when business is bleak the brokerage firms may not be able to justify the salaries paid. 

Thanks to a hollow market, trading volumes have shrunk drastically which has put a lot of pressure on the profitability of the business. This had led some of them to cut costs. According to media reports, some top firms like Motilal Oswal Securities and Mangal Keshav have started reducing staff from their mid-level and junior levels. 

There have been instances where brokers have moved from the institutional brokerage business into the retail business, or into selling non-equity products. But these moves have not been rewarding. 

The problem of institutional brokers comes close on the heels of what retail investors have been facing. Retail investors have been treated shoddily by the stock market system comprising of broking firms and the market regulator. Retail investors are not desperate to come back to the securities markets any time soon. And brokers find it difficult to get back retail investors as rising costs and minimal commissions make it difficult for them to cover promotional expenses. Along with cost issues, there is heavy competition as well in this business, leading to a multitude of brokers and too few investors. 

However, the irony in all this is that while investors have deserted the market and stock brokers are making losses, the coffers of regulators and other market infrastructure institutions are overflowing. In 2009-10, the National Stock Exchange (NSE) had made a profit of Rs613.77 crore on a turnover of Rs1,266.38 crore. The Bombay Stock Exchange (BSE) made a profit of Rs212.94 crore on a turnover of Rs485.21crore. Another extremely profitable institution is the National Stock Depositories (NSDL), which made a profit of Rs73.47 crore on a turnover of Rs317.48 crore. The most prosperous in all this bleak scenario is the Securities and Exchange Board of India (SEBI) that raked in Rs100 crore in fines and penalties alone. 

While everybody has contributed to this skewed situation, the man who was mainly responsible for the mess, CB Bhave, went out like a hero to the combined drumbeat of every single media organisation. Of course, history has a way of catching up with things and these days it is rather quick. 

Mr Bhave's role in the initial public offer (IPO) scam of 2003-2006 will come up for discussion when SEBI reopens the probe into the multi-crore scam, following the intervention of the Supreme Court. The meeting will relook at a report prepared by a two-member committee, comprising then SEBI board members G Mohan Gopal and V Leeladhar, that was appointed by SEBI in 2008 to investigate into NSDL's role in the IPO scam. The committee found various lapses on the part of the depository (which was then headed by Mr Bhave), as also SEBI itself. But in an extraordinary move, the SEBI board declared the findings as 'null and void' on the ground that the committee had breached its mandate in making these charges. 

SEBI was supposed to discuss this afresh at its board meeting on 30th June. But the meeting has been postponed, ostensibly because the SEBI chairman is travelling. The real reason could be that two of the SEBI members who had gone out of their way to defend Mr Bhave and put down the two-member committee, will be retiring soon. The board can decide things with a fresh and open mind. There are a lot of things SEBI needs to look at with a fresh and open mind about market development issues.