INDIAN BROKERAGE INDUSTRY

ICRA RESEARCH SERVICES INDIAN BROKERAGE INDUSTRY Financial Sector Ratings ICRA RATING FEATURE Contacts: Karthik Srinivasan +91 22 6179 6365 karthiks@icraindia.com Vibha Batra +91 124 4545 302 vibha@icraindia.com Initial signs of industry consolidation amidst another year of challenges for brokerages October 2013 ICRA LIMITED P a g e 1

INDIAN BROKERAGE INDUSTRY Initial signs of industry consolidation amidst another year of challenges for brokerages Executive Summary October 2013 ICRA RESEARCH SERVICES The financial year FY12-13 turned out to be more difficult for the domestic broking industry than the previous year as the macro-economic environment remained challenging notwithstanding short periods that hinted at a possible reversal. The continued global headwinds on account of expectations of the tapering of the Quantitative Easing by the Federal Reserve, deceleration in the domestic growth indicators and the sharp depreciation of the local currency, especially after Q1FY13-14, ensured that many investors continued to stay away from the domestic capital markets. At the industry level, Equity average Daily Volumes (ADV) rose by ~18% to Rs. 419 trillion in FY12-13 buoyed by the continued rise in volumes of option trading, which accounted for ~76% of overall market volumes in FY12-13 (~68% in FY 11-12). On the other hand, volumes in cash trades dropped by ~5% in absolute value and accounted for ~8% of overall market volumes whereas volumes in futures trading dropped by ~12% in absolute value and accounted for ~16% of total volumes in the same period. The trend continued in the current year as well with market volumes increasing by an annualized 17% in Q1FY13-14 but the share of cash volumes further reduced and constituted less than 7% of overall traded volumes, declining even in absolute number in the period (annualized) over FY12-13 levels. Anecdotal evidence suggests that the options volumes continued to flourish as HNI investors and institutions increased their activity levels at these counters. With lower activity levels in other capital market activities such as wealth management, investment banking and proprietary arbitrage trading, the brokerage industry had another challenging year in FY12-13 and is likely to have a difficult time this year as well on the back of a weak outlook. Not surprisingly, retail broking segment struggled even more in FY12-13 and the steep decline in prices of small and mid-cap scrips around the middle of FY12-13 added to the decline in retail participation in the cash markets. While most retail brokers have re-oriented their business models aggressively and increased the variable component in their cost structures, the lower activity in the retail segment and the investors shift towards the options segment have put pressure on the overall brokerage revenue pool. As per ICRA s estimate, the overall retail segment equity brokerage revenue pool has declined by ~10-12% from ~Rs 80-85 billion in FY11-12 to Rs 71-76 billion in FY12-13. As expected by ICRA in its earlier reports on the Brokerage Sector in FY12-13, the industry is witnessing signs of consolidation. The market share of the top 100 brokers on the NSE has increased substantially to ~89% as at August 2013 from 77% as at March 2013 and 73% as at March 2011. With companies needing to continuously spend on upgrading their technology framework, the current environment provides opportunity for the larger players to further consolidate their positions. Further, we believe that the mid-sized brokers are being forced to cut back and shut businesses in those areas where they do not have scale whereas some of the smaller brokers face survival issues. The impact of the regulatory cap on brokerage for domestic institutional investors (DIIs) 12 bps on cash trades and 5 bps on derivative trades has adversely impacted the institutional equities segment. Yields for the better part of FY12-13 remained under pressure as clients renegotiated the commission structures with brokerages. Further, competition amongst the existing players as they looked at opportunities to absorb fixed overheads also accentuated the revenue woes for this segment. ICRA believes that the overall institutional brokerage pool has undergone a significant downsizing. The institutional equities brokerage revenue pool, estimated at ~Rs 24-26 billion for FY 11-12, would have been closer to Rs 20-22 billion for FY12-13. With pressure on revenues institutional brokers too have turned to cost control as firms have begun downsizing analyst teams and also trying to differentiate themselves by providing more relevant corporate access to investors. ICRA believes that with revenue being under ICRA LIMITED P a g e 2

pressure, most cost control initiatives having run their course and factoring in the initial trends of the year till date, FY13-14 could remain a difficult year for institutional brokers. In aggregate, in ICRA s opinion, the retail and institutional brokerage revenue pool may have declined to ~Rs 90-95 billion in FY12-13 from ~Rs 105 billion in the previous year. If the trends of Q1FY13-14 were to be extrapolated, the annual brokerage revenue pool may have shrunk by further Rs 4-5 billion. The commodity and currency segments provided opportunities to the brokerage companies for diversification in revenue streams by leveraging the existing resources and networks. However, imposition of Commodities Transaction Tax with effect from July 2013 eroded trading volumes by as much as 30-40%. Nonetheless, since there is scope for proprietary activity at these counters, the impact on the revenue pool may not be as much as the drop in trading volumes signifies. The impact of the recent events at the National Spot Exchange (NSEL) on customer behavior remains to be seen. On the currencies side, the recent SEBI regulations limiting open positions for clients across all contracts and RBI restricting proprietary trades by banks have led to ADV dropping by ~50% from the peak of June 2013. As per ICRA s estimate, in aggregate, the commodities and currencies brokerage revenue pool for FY12-13 accounted for Rs 17-18 billion, representing a decline of ~10-15% when compared to FY11-12 and is likely to decline further by 5-15% in FY13-14. FY12-13 marked a challenging year for capital market financing NBFCs with lacklustre equity capital markets in general and in particular for the small cap and mid-cap scrips. While anecdotal evidence suggests that the overall capital markets financing book has declined by ~10-15%, ICRA s estimates for the top 18 brokers and capital market NBFCs suggests that the book size has actually increased by ~28% to Rs 242 billion in FY12-13. This growth has been largely led by expansion by a few players. However, the mix of the book size has shifted by only about 100-200 bps in favour of margin funding. This expansion in lending in an environment of declining stock prices and generally pessimistic outlook for capital market NBFCs could have an impact on the credit losses going ahead, if not backed by rigorous risk management practices. ICRA estimates that the total broking revenue for 15 prominent brokers increased by a nominal 2-3% in FY12-13. However, within the total revenue, contribution from brokerage activities declined and the increase was contributed primarily by an uptick in lending activities. On the costs front, despite the generally high inflationary conditions those were prevalent right through FY12-13, the overall operating costs declined by ~4-5% in absolute number as brokerages were able to prune both employee expenses as well as administrative expenses. As a result, overall operating efficiency improved and average cost income ratio declined by 600 bps in FY12-13 when compared to FY11-12. However, ICRA notes that with additional thrust on capital market financing, virtually no capital raising and moderate internal capital generation, at a consolidated level (adjusting for non-capital market businesses of some entities), gearing levels have gone up to ~2 times as on March 2013 from ~1.5 times as on March 2012. We believe that the declining trend in retail participation is unlikely to reverse in the short term while the competitive pressures could continue to perturb the industry. With continued uncertainties in the global and domestic environment, the current fiscal is likely to remain tough for the brokerage industry. However, we believe that the main beneficiaries are likely to be the bigger brokerage firms who could use their deep pockets to invest in growth for the future. 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 we have excluded ICICI Securities, J M Financial and Indiabulls Securities and included data for Anand Rathi group. ICRA LIMITED P a g e 3

This report includes an update on I. The equity markets in FY12-13 and Q1FY13-14 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. III. IV. The commodities markets in FY12-13 and Q1FY13-14.10 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 FY12-13 and Q1FY13-14.....13 a. Trends in exchange traded volumes b. ICRA s estimation of the currencies brokerage revenue pool Other capital markets related businesses.. 15 a. Key trends in investment banking operations and outlook b. Key trends in proprietary arbitrage operations and outlook c. Key trends in capital market lending operations d. Key trends in non-capital markets related forays and outlook V. Key Industry trends in FY12-13 and Q1FY13-14. 19 a. Key trends to watch out for in the institutional broking space Impact of capping of brokerage commissions for domestic institutional investors ICRA s estimation for the overall Institutional brokerage revenue pool Competitive landscape Update on Risk Management Mechanisms ICRA s views on industry consolidation b. Key trends to watch out for in the retail broking space Retail participation Impact on the retail brokerage revenue pool Trends in online trading Competitive landscape in Online trading Customer addition Branch and franchisee addition Outlook on retail broking VI. The performance for FY12-13 for 15 top brokers.... 27 a. Trends in capital markets related revenue ICRA LIMITED P a g e 4

b. Trends in operating costs c. Analysis of profitability and profitability linked ratios d. Gearing levels VII. ICRA s outlook for the Brokerage Sector for H2FY13-14 30 ICRA LIMITED P a g e 5

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