Anticipated Changes and Evolution in Indian Stock Broking Industry The recent hiatus in the Indian Bull Run will compel the stock broking industry towards changes it needs and has been silently yearning for. Forthcoming adjustments will span much expected areas such as consolidation, realignment of client acquisition and retention strategies along with drifts in regulations in conjunction with the much discussed shift between commission and fee based income. From a peak of 21,206 on January 10, 2008 on the BSE Sensex to a subsequent decline to a low of 7,697. 9 on October 27, 2008, the journey of financial markets in India has been capricious. With FII’s making a net sale of $ 10. 9 bn during 2008-09 (uptil January 16, 2009) as against net purchases of $15. 8 bn in the corresponding period of the previous year the bolt of volatility experienced left even experts flummoxed and raised concerns towards the ability of brokerage firms to deal with the cyclical sways of the stock markets. The Indian broking industry is reasonably large and fragmented with 9,000 odd brokers in the cash segment and around 24,000 sub-brokers.
The market share of the top ten brokers in India has remained largely stagnant in the past four years. The top five brokers in India still control around 15-16% of the market share. Historically, retail trading contributed around 60% of the market and FII’s averaged around 20%. Key developments in this industry included conspicuous expansion in distribution pan India with greater diversity offered in financial product offerings and an increased emphasis on proprietary research output. There was a greater than before interest towards engendering a global footprint.
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With over half of financial savings still in bank deposits and equity assets comprising of only 6% of household financial savings the under penetration and relative financial illiteracy continue to ensure the allure of financial services segment in the country. The recent financial crisis though has had a dampening effect in the short term on the momentum, has along side shaken the industry to recognize the excesses built in the near decade long Bull Run and provided the opportunity to firms to rethink their likely business models in the long run.
As expansion in network no longer serves as an easy way to win customers, brokerage firms will be compelled to examine their customer retention and servicing efforts in greater minutiae. And, as the industry progresses on the growth cycle the following changes are anticipated in the brokerage industry Realignment of Business Models between fees based and commission income Brokerage firms in spite of their bid towards diversification derive their largest chunk of revenue from pure play securities broking.
With explosive expansion in the business over the last few years the focus of the business has largely been towards opening offices, hiring relationship managers and acquiring clients. Once the acquisition has been achieved, through an attractive combination of lower intraday rates versus delivery, clients are encouraged to churn their portfolios in the market, supported by equities research and largely the client dealer relationship. Income from broking continues to be transaction driven and hence acutely subject to the cyclical nature of the market.
Downturns such as the one we are experiencing have thus compelled broking firms to weigh their decisions around the business model that they have followed over the last few years. While the model holds depth in a bull run when ‘everyone is right’ and headed in the ‘right direction’, the foundation it provides lacks the stability and sustainability in the long run. With margins shrinking in spite of low levels of penetration in the country brokers will need to differentiate on the quality of value added services that can be provided.
One such service is going to be ‘Financial Advisory’ which continues to be unorganized and lacking accountability in India. In an effort to drive revenues that are annuity based, brokerage firms are likely to segregate transaction based charges from advisory based fees, a trend experienced in the mature economies as well. This in turn will introduce new waves of quality control and checks within the broking houses allowing for improved relationships with the clients. This will be complimented by improved retail financial planning that remains more of a concept in the current markets.
Advisory related fees will also introduce greater stability in the income stream which currently suffers from significant duress. This drift will drive broker segmentation as well between a full service advisory fees led broker and a no frills online discount broking player as seen in mature economies, clarity around which in India is currently missing. The fall in the markets has definitely caught the eye of a retail investor towards the need for greater information and awareness around financial markets.
Investors are likely to demand greater protection of their assets and will be severe in assessing whether they are receiving their money’s worth. There will be a clear delineation between the short term and long term aspirations. The importance of strong differentiation and strategic positioning for broking houses cannot be overstated. Advisory services are likely to re-build the confidence required to get investors back into the markets and make them stay there. It will also bridge the gap in the current relationships between broking houses and their clients which currently tend to be entirely transaction driven.
Provision of the same level of service to all will fail as investors will demand bespoke solutions even in the retail segment. Even though SEBI has been contemplating the introduction of Advisory regulations in India for some time, the current downward spiral is likely to expedite this for better protection of retail investors. Client Segmentation How well do Brokers know their clients? Broking firms will need to clearly identify client segments and build capabilities around serving them. Clear matrices of client aspirations will drive brokers from transaction based churn of portfolio to accumulating wealth to preserving it.
Besides generating return brokers will need to manage client cash flows, thus allowing for a client centric approach in management rather than just product provision. Cross selling of products will also be vital for client retention. Servicing clients through these changes will thus create the need to handle much more than their assets. Retail segment in India given the numbers yet untouched, offers an unprecedented scale. However, to best capitalize on this broking firms will need to stand out clearly in terms of the value proposition – and client connect and understanding is going to be a critical factor.
Social Capital The importance of client Trust in India remains understated. Long term viability of any broking house will be driven not only by the level of expertise it offers but also by professional integrity and objectivity it exudes. With anticipated increase in demand of customized solutions trust will be a foremost factor driving client retention. This would require a cultural drift in broking houses both in terms of internal policies as well as in terms of the employees hired who are able to convey the same to the clients. Tech Empowerment
Broking firms are likely to invest further in superior technology driven solutions to better manage client risk across asset classes rather than pure play stock broking. An expected introduction of superior and more stringent transparency measures and performance accountability will result in broking firms earmarking significant budgets for tech related developments and implementation. The flow of information from the firm to client is likely to become more evolved towards analytics of the latter’s portfolio rather than simple reporting mechanisms especially as the market moves away from simple ealer driven trading to advise based portfolio management. Consolidation Consolidation has been more of a myth as the industry remains quite fragmented. Most brokerage firm’s value proposition in the past has been positioned towards supporting their respective listings rather than building strong cash flow positions. With the availability of the leading spot in the market and the current financial crisis that will allow for introduction of newer business models, a buying spree is likely to emerge.
Established players with significant cash flows and strong balance sheets are likely to change the competitive landscape at the regional and local levels, which will be further facilitated by the anticipated changes in regulations. Bouquet Services Expertise and personal attention will have to be matched with comprehensive solutions. Broking firms have witnessed an expansion in the bouquet of products and services that are able to address most of the client’s financial requirements, though the phenomenon is limited to firms offering wealth management services largely.
Firm based delivery rather than individual based is critical to tie a client to any given firm. Broking houses will tie their product and services expansion and development strategies to initiate greater client loyalty through seamless internal integration and improved market share via innovative acquisition. Change in Institutional Focus The recent rush in setting up of institutional business resulted in a congestion. It further suffered a major hit with the FII’s redemption spree. Going forward FII’s are expected to choose brokerages that are available to serve them for large cap stocks in multiple countries rather than just one.
Given the market scenario this is likely to result in an innovative realignment of the institutional strategy towards building capabilities to support multiple geographies. Global Footprint Established broking houses in the country are likely to look outward to tap the global markets in its bit to diversify both income streams and audience. Also, with greater global integration and convergence in business models, broking houses with captive international client sets are likely to be able to balance their businesses better.
In spite of the recent pessimism around financial services industry in the country, the level of under penetration along with the relative adolescence of the market coupled with the proactive role of India’s regulators to better protect investors, offers immense opportunity. Over the next few months we can expect fundamental changes in the business models of broking houses. The awaiting client opportunity along with a paucity of advisory and high premiums that an advisory model can offer is likely to result in a cultural shift in the entire industry.
While changes in regulation will provide the first stepping stone in expediting this, innovative adjustment to the new market realities will facilitate firms towards better and protected margins. In fact advisory complemented by leverage will be an imperative combination towards capturing market share especially once the markets look up. Progress will happen and the metamorphosis that it is likely to emerge will change the structure and culture of Indian broking firms. Broking firms that are able to reinvent themselves on similar lines will be able to capitalize on the changing paradigms and are likely to emerge as the next industry leaders.