In October 2019, when some big stock broking firms in the US introduced no commission platforms, it created a buzz on Dalal Street in India and among investors who thought that Indian broking firms will also follow suit. But that wasn’t going to happen.
Nithin Kamath, founder of India’s largest stock broking company, Zerodha, commented and explained the reasons on Twitter why India can’t follow the US model of zero per cent brokerage on trade.
Why Did US Brokerage Houses Go For Zero?
Several US brokerage companies with billions of dollars in brokerage revenue decided to adopt the zero-brokerage model of business starting from early 2018. The US stock market is a lot older than the Indian market and hence a lot different too. Subtle differences like handling of client’s trades to off-market share exchanges, client’s fund holdings, and other related works are handled differently. Due to these differences in the handling of processes, the US brokerages could go for charging zero brokerage on trades.
What Are The Differences?
1. Client’s Fund Holdings In Cash
In India, the capital market regulator, the Securities and Exchange Board of India (Sebi), has mandated that all stock brokers registered with various Indian stock exchanges have to return any idle fund kept in their client’s trading account once every quarter. If any stock broker does not refund the client’s idle cash holding due to any specific rule or exemption, the broker will have to issue a ‘Retention Statement’ and explain why the refund was not made.
The US does not have such a rule and hence stock brokers are free to use their client’s idle cash balance to earn some notional interest income if they want. But if the clients demand that their cash be transferred back, the brokerage has to comply.
2. Payments For Order Flow
In India, it is mandated that anybody who wishes to trade in securities at a stock exchange can only do so via a registered stockbroker or recognized stock exchange. The Web interface or direct market access portal is to be provided by the broker upon request by the client or by any pre-defined agreement. Every order must compulsorily be sent to the specified recognized stock exchange and nowhere else.
"In India, all orders placed on a broker’s trading platform are sent to the exchanges in real-time for matching and fulfilment. Stock exchanges here earn by charging transaction fees on such orders. In the US, a stock exchange’s main source of income is from selling data feed,” said Kamath in his tweet.
In India, brokerage changes are usually 0.01-0.1 per cent or a flat fee per trade of Rs 15-20.
The US Securities and Exchange Commission (SEC) has mandated that the price at which the client would buy a share should be the same as the National Best Bid and Best offer (NBBO) but the order may or may not be sent to the stock exchanges. So what most brokers who follow the zero per cent brokerage model did was that they sold their clients’ order data to other hedge funds and high-frequency trading firms for millions of dollars. Doing so is not legal in India.
3. Securities Holding
In India, the securities traded in stock exchanges are held in demat accounts maintained by two depositories--National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL), which are independent of a stockbroker and stock exchange’s operation. In the US, the clients' securities are held in a ‘books and records’ system which is maintained by the stockbrokers themselves. So, while US stockbrokers can lend these securities freely and earn interest income, Indian brokers cannot do that with retail securities. In India, there is a Securities Lending and Borrowing protocol, which retail investors can avail but they have to voluntarily participate in this, unlike in the US.
“In India, brokers can’t lend securities as those sit in the clients’ demat accounts with the depositories. (However,) India does have an SLB (Stock Lending and Borrowing) platform where clients can participate directly,” said Kamath in his tweet.
All of these additional revenue sources allow US stockbrokers like Charles Schwab, TD Ameritrade and Robinhood to charge no brokerage on trades. The Indian stock market is relatively new compared to the US market. As the volume of trade increases and more people participate in the stock markets, we could expect brokerage charges to reduce in future.
