Discount brokerages and Margin Financing in India

Indian Brokerage Industry is going through a lot of interesting changes. While the most obvious change across all major Brokerages houses is proliferation of technology in different aspects of execution, research and distribution channels, the model of discount brokerages has caught everyone's attention. From a business perspective, brokerage houses are already tackling with gradually decreasing brokerage revenues because of free market pricing causing brokers to reduce brokerage costs or moving to flat fee structure instead of percentage of transaction value to get a market share, several discount brokerage firms took to a different level by even allowing clients to invest in shares for free. 

These same discount brokerage firms now are looking at expanding their businesses through alternative means and are looking at lucrative segment of margin financing to compensate for the zero or near-zero levels of brokerage that they charge for normal trades. Margin Financing as a term refers to lending money to clients to trade in shares and charge interest for the amount of money financed. Simply put, a client has 1 million in his account but he can trade in shares worth 3 million. Rest of the money is financed by the brokerage and it charges a daily interest on the money financed. From a regulatory aspect, Brokerage houses are trying to get clarity if they can provide the margin funding through the brokerage entity or they to need to have a separate NBFC arm which can provide the financing.

In this article, I would want to bring in several more aspects related to Margin Financing and how Margin Financing is a complex thing in global financial markets. Firstly, Margin Financing is of interest to large investors/traders who prefer to do large trades with margin money. Their trading decisions incorporate cost of capital and they look for competitive financing rates for good returns. Retail Investors generally do not take leverage and stick to a delivery based trading. Talking about large investors/traders, we cannot miss the Global Hedge Funds who trade globally across exchanges and market in a diverse set of assets both in Listed and OTC space. They are one of the biggest beneficiaries of Margin Financing and it is an integral part of their trading strategies across all the asset types.

Global Hedge Funds go into complex Margin agreements with their Counterparties/Prime Brokers to margin their funds trading. The agreements are complex rules which defines how much margin needs to be paid at the end of day for the portfolio. These rules are extremely complex and incorporate all the risk attributes of the asset being traded where Counterparties/Prime Brokers put lot of research to define the margin rules to mitigate every kind of risk the asset can entail in any kind of market situation. On the other side, the Hedge Funds look at a competitive margin agreements which allow them to take leverage in the highest extent possible so that their cost of capital is minimized.  The most complex agreements even allow reduced margin for assets hedged through derivatives and even cover exchange required margin for listed derivatives.

Coming to the Indian context, Margin Funding has been a lucrative segment for the large brokerage houses along with loan against shares. With discount brokerage players coming into this space, there will be some friction and I expect the margin financing market would go through a major evolution like how it has reached in the globally developed Markets. In simpler terms, this would mean lot of research would go in modeling margin financing terms which not only mitigates the risk of the broker in case of a volatile market but at the same time providing competitive margin terms to large Investors to capture the major share of the margin funding market. 

On an ending note, the most important enabler would be the Technology in all these aspects. None of the Financial services business can scale without strategic investments in technology to deal with the future complexities and innovation.