Discount brokers' topline might be hit badly if Sebi restricts F&O trading

Discount brokers' topline might be hit badly if Sebi restricts F&O trading

Digital and new-age discount broking firms will be badly hit if the markets regulator Sebi places any restrictions on futures and options (F &O), also called derivatives trading.

Last week, Sebi Chairperson Madhabi Puri Buch said that the market regulator will be open to taking derivative products off the shelf if the expert committee deliberating on the segment recommends it.

While the number of F&O traders is between 10-20 percent of the overall active client base, they generate between 60-70 percent of the revenue for most of the large brokers.

Among the top four discount brokers, companies like Zerodha, Groww and Upstox are privately held and the numbers are not known. It is estimated that Zerodha has a higher mix of F and O traders and contributes to around 70-75 percent of the topline and bottomline.

Digital brokers charges a flat fee of Rs 20 or less per trade and focusses on scale and hence called discount brokers. The traditional brokers provide research and investment services to their customers.

Among the top four digital discount brokers, the third largest player Angel One is public and according to the company’s investor presentation for the Q4, FY 24 revenues, 68% of the revenue came from broking. Out of the broking revenue, 85% came from F & O trading. That is around 60 percent of the overall revenue.

“Among the top four, my guess is that Angle One is likely to have a lower mix of F & O revenue because they still have some of the old customers who are paying fees for cash equities,” said a consultant with one of the top four audit firms.

However, the Angel One shares did not see any dramatic fall either on June 28 or on July 1. The shares were down 0.7 percent on July 1, when the overall market went up by 0.43 percent during noon.

Volumes, a cause for concern

According to Sebi, around 90 percent of F & O traders lose money. The F & O trading volume constitutes more than 99 percent of all trades on the most popular exchanges - NSE and BSE.

To put the numbers in context, in the US, derivatives trading constitute only 70 percent of the overall market trading volume. Last month, RBI governor Shaktikanta Das also mentioned that the F and O frenzy in the country is being monitored by the central bank.

This is one of the biggest reasons why there are multiple discussions on the subject.

Zerodha founder and CEO Nithin Kamath acknowledged that the company has been one of the biggest beneficiaries of this growth.

“We are in the middle of a period of excess in options trading. Volumes in index options have gone up from 4.6 lakh crore in 2018 to 138 lakh crore in 2024, and, more importantly, the share of retail has gone up from 2% to 41%,” Kamath said in a post on social media platforms.

“We have been a big beneficiary of this jump in volume but have always been aware that it can be significantly reduced in size due to regulations, which can significantly hurt revenues, and that's also why we have never made any forward projections,” he added in the post.

Kamath said that the times will be tough for the broking industry going forward because everyone’s business model is skewed towards earning from options.

Could alter business models

Another broking firm FYERS said that it would anticipate a reduction in trading volumes and possibly a shift in their product offerings. However, we are committed to adapting swiftly and ensuring that we continue to provide valuable services to our clients within the regulatory framework,” the company added.

The Sebi move could alter the market dynamics and liquidity apart from increasing the trading costs for consumers, according to FYERS.

“Market liquidity could be affected, which might result in wider spreads and increased trading costs. Investors might pivot towards other financial instruments or asset classes, altering the current trading dynamics and market focus.

Around 15-20 percent of brokerage income comes from interest from the money they derive from keeping customers’ funds. If these customers move to cash market, they will likely see this income go up gradually.

However, all these cannot compensate for the loss of derivatives trading because of the 70 percent contribution to revenue and profits.

Putting up a brave face

Meanwhile, all the broking firms said that this could help increase the stability of he markets as well as customer confidence in trading in the market, prompting a lot of investors to look for cash market trading.

Kamath of Zerodha said that the company has always maintained that the biggest risk for any regulated entity is the change of regulations.

The discount brokers have been maintaining that they have been educating customers on the potential risks for a long time and they understand the market volatility as well the risk that comes with derivatives trading.

Zerodha’s Kite app has been showing a pop-up message on 90 percent of F & O traders losing money.

Groww founder Lalit Keshre said that the company is helping customers mitigate the risk of losing money by building a “Safe Exit” feature.

“Customers can define the maximum amount they can afford to lose, and the positions are squared off as soon as the loss threshold is reached,” Keshre said adding that the product has seen a 25 percent adoption among derivative traders.

According to Keshre, when customers place an order where the probability of losing is high, the company warns customers before placing an order. “Voluntary pause of F&O by customers stronger suitability check in F and O onboarding based on income and net worth warning to customers when they keep  losing money continuously,” he added in a post on X.

Clearly these measures have not been enough with more retail customers turning towards F & O, prompting Sebi to consider restrictions.

“This is a positive step towards enhancing market strength by protecting investors from low liquidity and underperforming stocks. According to me, this revisiting was long overdue, given the ballooning derivatives market in India,” said Devam Sardana, business head, Lemonn, a trading platform.

The company said that without sweeping restrictions, trading is unlikely to come down. “Despite this, we anticipate that volumes would not decrease by more than 20-30% (for the industry), as the majority of derivatives volumes (70-80%) are contributed by institutions, proprietary traders, and high-net-worth individuals (HNWIs),” Sardana added.