INDIAN BROKERAGE INDUSTRY

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1 ICRA RESEARCH SERVICES INDIAN BROKERAGE INDUSTRY Financial Sector Ratings ICRA RATING FEATURE Contacts: Karthik Srinivasan Vibha Batra Brokerage industry developing into a winner takes all market; Near Term outlook contingent on outcome of the General Elections May 2014 ICRA LIMITED P a g e 1

2 INDIAN BROKERAGE INDUSTRY Brokerage industry developing into a winner takes all market; Near Term outlook contingent on outcome of the General Elections May 2014 Executive Summary ICRA RESEARCH SERVICES 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 ICRA LIMITED P a g e 2

3 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 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 ~ bps for 9MFY14 compared to ~ 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 % 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 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 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 ICRA LIMITED P a g e 3

4 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 bankerbrokers 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. This note covers the financials of 15 1 entities. However, for market share, brokerage revenue pool analysis, ICRA has used data for 13 2 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. ICRA LIMITED P a g e 4

5 This report includes an update on I. The equity markets in FY 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. III. IV. The commodities markets in FY 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 The currencies markets in FY a. Trends in exchange traded volumes b. ICRA s estimation of the currencies brokerage revenue pool Key Industry trends in FY 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 VI. ICRA s outlook for the Brokerage Sector for FY ICRA LIMITED P a g e 5

6 Please contact ICRA to get a copy of the report CORPORATE OFFICE Building No. 8, 2nd Floor, Tower A, DLF Cyber City, Phase II, Gurgaon Ph: , Fax; REGISTERED OFFICE 1105, Kailash Building, 11 th Floor, 26, Kasturba Gandhi Marg, New Delhi Tel: Fax: MUMBAI Mr. L. Shivakumar Mobile: , 18 th Floor, Tower 3, Indiabulls Finance Centre, Senapati Bapat Marg, Elphinstone, Mumbai Ph : , Fax : shivakumar@icraindia.com GURGAON Mr. Vivek Mathur Mobile: Building No. 8, 2nd Floor, Tower A, DLF Cyber City, Phase II, Gurgaon Ph: , Fax; vivek@icraindia.com CHENNAI Mr. Jayanta Chatterjee Mobile: Mr. Leander Rayen Mobile: th Floor, Karumuttu Centre, 498 Anna Salai, Nandanam, Chennai Tel: Fax: jayantac@icraindia.com leander.rayen@icraindia.com KOLKATA Ms. Vinita Baid Mobile: A-10 & 11, 3rd Floor, FMC Fortuna, 234/ 3A, A.J.C. Bose Road, Kolkata Tel: / 8839, , Fax: vinita.baid@icraindia.com AHMEDABAD Mr. Animesh Bhabhalia Mobile: & 908 Sakar -II, Ellisbridge, Ahmedabad Tel: /2008/5494, Fax: animesh@icraindia.com HYDERABAD Mr. M.S.K. Aditya Mobile: , CONCOURSE, 3rd Floor, No , Ameerpet, Hyderabad Tel: , Fax: adityamsk@icraindia.com PUNE Mr. Amit Khare Mobile: A, 5th Floor, Symphony, S. No. 210, CTS 3202, Range Hills Road, Shivajinagar, Pune Tel : , /196, Fax : amit.khare@icraindia.com BANGALORE Mr. Jayanta Chatterjee Mobile: 'The Millenia', Tower B, Unit No. 1004, 10th Floor, Level 2, 12-14, 1 & 2, Murphy Road, Bangalore Tel: , Fax: jayantac@icraindia.com ICRA LIMITED P a g e 6

7 ICRA Limited An Associate of Moody's Investors Service CORPORATE OFFICE Building No. 8, 2 nd Floor, Tower A; DLF Cyber City, Phase II; Gurgaon Tel: ; Fax: info@icraindia.com, Website: REGISTERED OFFICE 1105, Kailash Building, 11 th Floor; 26 Kasturba Gandhi Marg; New Delhi Tel: ; Fax: Branches: Mumbai: Tel.: + (91 22) /53/62/74/86/87, Fax: + (91 22) Chennai: Tel + (91 44) /9659/8080, / 3293/3294, Fax + (91 44) Kolkata: Tel + (91 33) / / / , Fax + (91 33) Bangalore: Tel + (91 80) /4049 Fax + (91 80) Ahmedabad: Tel + (91 79) /5049/2008, Fax + (91 79) Hyderabad: Tel +(91 40) /7251, Fax + (91 40) Pune: Tel + (91 20) /95/96, Fax + (91 20) Copyright, 2014 ICRA Limited. All Rights Reserved. All information contained herein has been obtained by ICRA from sources believed by it to be accurate and reliable. Although reasonable care has been taken to ensure that the information herein is true, such information is provided 'as is' without any warranty of any kind, and ICRA in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness or completeness of any such information. All information contained herein must be construed solely as statements of opinion, and ICRA shall not be liable for any losses incurred by users from any use of this publication or its contents. ICRA LIMITED P a g e 7