Large brokers like Zerodha and Upstox need to make greater disclosures

Undoubtedly, this would have led bankers to make a beeline for Zerodha, suggesting a deal either in the private capital markets or to take the firm public. However, Nithin Kamath, the firm’s founder, is not interested. “Listing is not on our agenda currently as we have no need for capital, and we are providing liquidity to employee stock option holders through a buyback of shares," he said. In fact, in a tweet that was widely shared by financial market participants, Kamath said it is probably the stupidest time for fintech firms to raise money. “We prefer being a private firm as it enables us to take risks and be nimble without worrying about public investors, who tend to have a short-term mindset," he said in an interview.

With a pre-tax profit of nearly ₹600 crore in fiscal 2020 and a 2.5 times jump in clients since the outbreak of covid, the firm doesn’t need the funds either. Yet, while fundraising or an initial public offering (IPO) may not be on its agenda, Zerodha has grown to a very large scale of operations. As of March 2020, it had a nearly 20% share of all active clients on the NSE, and its FY20 profit was more than four times the consolidated profit of BSE. For its 3.6 million clients, it is as important as an exchange.

This raises the question of whether there is enough in terms of disclosures and public information on such an important institution.

“Critical financial market infrastructure entities such as exchanges and depositories are subject to high standards of disclosure requirements even if they are unlisted. There is a case for extending this to other systemically important financial intermediaries. The recent episode relating to Robinhood in the US suggests that broking firms who operate on a large scale with millions of customers are systemically important and require greater scrutiny," said J.R. Varma, professor of finance at the Indian Institute of Management, Ahmedabad, and a former board member of the Securities and Exchange Board of India (Sebi).

Robinhood had a crisis earlier this year when a trading frenzy in certain stocks such as Gamestop required huge additional collateral to be deposited with exchanges, and the firm had to raise emergency capital. If Robinhood had shut, it would have been as bad as an exchange shutting down for its 13 million customers. As such, regulators need to be on the guard when it comes to large intermediaries.

Varma had made the case in 2017 that Sebi seems to be more aggressive in requiring listed companies to disclose material information than it is for regulated entities. Since then, disclosures by NSE, which is unlisted, have improved. While financial information of unlisted firms such as Zerodha is available on a government website, it isn’t easily accessible and comes with a wide lag. Also, while broking firms report financials more frequently to exchanges, these are non-public filings. It is also important for their users and the markets to have this information, especially in light of Robinhood’s troubles earlier in the year.

There have also been whispers and allegations that Zerodha’s high profitability can’t be explained just by transaction fees, but is because of trading income. Kamath has clarified in a blog post that the firm no longer does active trading. Disclosures on different revenue streams, however, would be the best defence against any such concerns in the market.

“Apart from disclosures regarding their financial condition, it would be important to monitor their technology and security capabilities," Varma said referring to systemically important financial intermediaries

Upstox, the second-largest broking firm in the country, recently reported a security breach in its systems. The firm had an active customer base of 2.1 million in March 2021, according to NSE data.

Zerodha is regularly trolled on social media for outages, though Kamath said in the past year the firm has had a total of 1.5 hours of downtime, claiming it is lower than other top brokers. He scoffed at the suggestion that large fundraising could help the firm upgrade technology and fix problems. “Money doesn’t solve technology problems. If that were the case, large corporations such as Google will never have an outage, but the fact is they do," Kamath said.

Again, disclosures can help. Market participants should be able to compare firms on technology investments, security measures, and downtime statistics. Needless to say, the regulator would need to play a role here to ensure disclosures are standardized and audited.

A call for greater disclosures certainly comes with higher costs. “More disclosures are always good, but can be onerous and costly for small firms. As such, Sebi can look at a threshold beyond which certain disclosures are mandated," said Ram Thirumalai, associate professor of finance at the Indian School of Business. If the threshold is kept at the 5% market share level, for instance, Zerodha, Upstox, ICICI Securities, Angel Broking, and HDFC Securities will be required to make additional disclosures. The five firms accounted for a 53.6% share of the entire market. Groww isn’t far behind with a 4.3% share, garnered in less than a year.