How is the recent cap on the amount of brokerage and transaction costs domestic mutual funds can pay brokers affecting the markets in general and brokers in particular?
According to the chief investment officer (CIO) of a large mutual fund, before the cap of 12 basis points (bps) came into place, they were paying around 15 bps. One basis point is one-hundredth of a percentage point. According to a sales trader at a multinational broker, the charges for domestic institutions ranged from 15 to 25 bps, depending on factors such as volumes, level of servicing, etc. The head of electronic trading for Asia Pacific at another multinational broker points out that after the cap on mutual funds was put in place, even insurance companies have been paying lower commissions. This means revenue for brokers have been hit by at least 20% for a large revenue stream.
Motilal Oswal, chairman and managing director of Motilal Oswal Financial Services Ltd, says that since there is a strong competition in the equity broking space, it makes more sense to let the market forces decide the brokerage, rather than have the regulator cap it at a certain rate. To be sure, the mutual fund CIO points out that brokerage has been trending down from 25 bps some time ago to 20 and then 15. The problem with an artificial cap is that brokers will be forced to trim costs to remain viable and, in the process, services to mutual funds will get affected.
The electronic trading executive says that his firm is now no longer able to service a broad range of clients, but has chosen to partner with some buy-side firms. Additionally, his firm isn’t pushing electronic execution aggressively anymore, since it earns relatively low commissions. Given the fact that the overall commission pie has shrunk, his firm has chosen to derive maximum value through the full service cash desk. If more firms follow this trend, it will again be to the detriment of mutual funds, as they will lose out on a cost-effective as well as efficient execution alternative.
One view of the situation is that Securities and Exchange Board of India (Sebi) is trying to fix something that isn’t broken. Another view is that the cap on commissions will help reduce unnecessary churning of portfolios. Either way, Sebi’s action is working to the detriment of the industry it is trying to protect.