Domestic brokerages are increasingly hiving off their margin financing business into non-banking finance companies to take advantage of a different set of regulations that they all say gives them more flexibility.
The shift to NBFCs, as such entities are called, allows brokerages to avoid capital market regulator Securities and Exchange Board of India (Sebi), as NBFCs are regulated by the Reserve Bank of India (RBI).
Margin financing helps an investor borrow cash from brokerages to buy securities. Brokerages charge interest on the cash that investors borrow.
“Sebi restricts the options of brokerages to use their surplus money, whereas an NBFC has the freedom to do whatever it wants with its money,” notes the chief executive of a leading Indian brokerage.
Mint spoke to four brokerage firm CEOs, none of whom were willing to be named because it involves regulators.
Large Indian brokerages, such as Kotak Securities Ltd, Indiabulls Securities Ltd, Motilal Oswal Securities Ltd, Sharekhan Ltd, Geojit Securities Ltd and India Infoline Ltd, have already set up NBFC subsidiaries that take care of their margin financing business. Other domestic brokerages, such as Brics Securities Ltd and Edelweiss Capital Ltd among others, also have NBFC licences from RBI.
Sebi guidelines on margin financing restrict brokerages to lend not more than 50% of the value of securities purchased by their customers. Besides, margin financing can only extended to a pool of 500 stocks, identified by Sebi.
“Some of these guidelines were issued in 2005 when the market regulator found some leading brokerages offering as much as 80% funding for buying stocks through their in-house margin financing process,” says another CEO of a domestic brokerage.
“When a new client or an investor opens an account with one of the top brokerages, they are first registered as a customer of their non-banking subsidiary,” explains a third CEO of a brokerage.
“The documentation is done in such a fashion that the brokerage is not directly involved in the funding process between the client and the NBFC. Once a new client or a new investor goes through this process, he is no longer confined to the Sebi norms on margin buying. This is because the NBFC acts an independent firm and is capable of funding an investor beyond the 500-scrip universe. Also, unlike a brokerage, an NBFC is free to fund over 50% of the securities purchased.”
“We have a proper risk management facility in place,” says a top executive of another major brokerage. “Sebi should not be worrying about the amount of risk that we are ready to take with our customers in the first place. Secondly, it’s ridiculous to have the same treatment for all the 500 stocks where margin financing is allowed. For instance, we should be allowed to fund more for the Top 50 scrips since the risk is lower there. Sebi should understand that there are large fundamental differences among many of these companies in their 500 scrip list.”
Margin financing, internationally, “is big business for brokerages”, notes Nimesh Kampani, chairman of JM Financial Group, the erstwhile Indian partner of Morgan Stanley Ltd. JM Financial is planning to start a new company, JM Financial Products and Services Ltd, an NBFC, fully dedicated to margin financing and securitising.
C.J. George, CEO of Geojit Securities, a leading brokerage in South India, also agrees that margin financing is one of the most attractive divisions of the equity broking business, noting that “some of the large global brokerages earn as much money from the interest rates on margin funding as their equity brokerage fee.”
V.R. Srinivasan, CEO, Brics Securities, however, is not so sure that the NBFC model helps brokerages escape the regulator.
“The NBFC model is customer driven,” he says. “There is strong urge from the customers to gain more products and services from a single shop. The brokerages are forced by this demand to distribute others products and services to the customer, which sometimes is not accepted by Sebi,” he adds.