Stock Exchanges are Killing Stockbrokers

The D2C supply model is taking the world by storm, and the investment environment is also ready to accept its destructive oppressor. Imagine this scene, the suited-booted stock exchange, ready to raze the slum of poor and old brokerage platforms. Not to mention the 100 million baby investors kicked to the curb along with these brokers. Feeling anxious yet?😥

Now, you wanna-be Buffetts, don’t get your tridents out just because I called favourite brokers “poor and old”... hear me out (Trident= Aquaman reference, promise)! Discount brokers don’t necessarily earn much, thanks to their USP, where they charge pennies for trades worth a lot more. Full-service brokers are like grandpas; outdated, overbearing, and obnoxious. Thus, my earlier claims are not untrue!

But I’m not just attacking a pre-established system without any sound reasoning. So, could I ask for a crumb of your attention? I’m about to break the system and blow your minds!

Breaking Down the Broking Industry

The broking industry is a house that is broken by its own members. But before we dive into what went wrong with the industry, let us find out what went right when it began. After all, India has the 11th largest stock exchange in the world. 😎

Broking initially was not just limited to the purchase and sale of shares. One of the earliest iterations, called Dalali, included a human attendant for the investors. The point of having a Dalal would be to provide hand-holding and advisory services to the investors. This system, however, was not very organised, which led to its inability to keep up with the growing number of investors.

The remedy to this snail trail of brokers came in the form of Full-Service Brokers. FSBs were created by either financial institutes or private firms specialising in broking services. Back when they were created, the ability to trade in shares was a by-product. The primary offering of Full-Service Brokers was the same as its ancestors; guidance in the world of investing. However, “service” seemed to be a word limited to only the names of these brokers, as the profit motives of the organisations soon started to cause a conflict of interest with the investors.

You see, while the brokers in an FSB would be liable to receive a commission, they would also earn on a “per-transaction” basis. This meant that if an investor interacted with the market a lot, the broker would earn a fat stack. Thus, brokers would mislead investors, manipulating their funds and portfolios to keep them hooked. The stock market was turned into the infamous “gamble”, with the brokers as dealers, and the famous gambling phrase, “The house never loses”, was beginning to ring true for the investors.

This is what sparked the inception of discount brokers, but this spark is what finally burnt the house down. The kind of ‘lit’ no one likes.

DI-Why?

Owing to the friction of interests between the brokers and the investors, autonomy was becoming a growing need for the latter. Come 2010, Zerodha (more like Hero-dha) entered the Indian investment arena and brought the arguably biggest paradigm shift the broking industry had seen since its creation. With the new challenger in the arena came a new weapon, discount broking.

Discount brokers, as their name suggests, provide investors with a platform to buy and sell securities at extremely reduced brokerages. The trade-off for these reduced charges came in the form of the removal of the advisory services that brokers initially provided. With finding discounts being every Indian’s favourite sport, this new version of brokers attracted investors like ants to syrup.

Whatever these discount brokers did sure seemed to work, as more and more discount brokers started popping up like termites from old furniture (getting “bugged”, yet?)

As you can see, the revenues of the broking industry in the year 2022 saw a meteoric rise from 2021 numbers. However, this growth spurt in the big broking bucks is not looking sustainable. The uptick in 2021-2022 was a result of the pandemic when people wanted to explore the avenues of investing. People had time and some money to spare, so lo and behold, everyone and their aunt is an investor.

But this DIY mentality soon led to discount brokers cannibalising not just the full-service brokers but the broking industry as well. Today, more and more of the investor base is seeking relevant literature to educate itself and taking matters into their hands. With the internet being an ocean of knowledge, brokers are reduced to nothing but a terminal for investors to transact on.

This is somewhat funny because the business itself is on the verge of being, well, terminal.

The Current System

Do you know banks? Of course, you do! We’ve all experienced banks in some capacity. As people exposed to the system, we know that banks are terminals of monetary transactions, stores of money and keepers of accounts & balances of their clientele. This clientele involves both the payer and payee on the same system of accounts. With the RBI governing the affairs of banks in India, the banking system in the country is quite unified and streamlined.

Now for a moment, try to equate the banking framework to the current investing environment.

Imagine a system where one organisation handles the accounts and has possession of funds. A different organisation provides the terminal for transactions. And a completely separate platform exists where two of the most significant parties to the transaction are housed, away from the rest of the concerned demographic.

Tedious, wasn’t it? Well, you’d be disappointed to find out that what you just imagined was a “names removed for subject’s safety” version of the Indian investment market (if I were as inefficient as the broking system, I’d prefer anonymity too)!

Break the Brokers

While we are still on the imaginary train to the make-believe land of perfect investing, let us reach a final stop; The Ideal Model. After all, all of us love to think about “what could have been” instead of focusing on “what is” (I’m looking at you, post-cricket match commentators/coaches)!

Looking at the graph above, you can see that the various players in the broking industry earned a total of ₹22,850 crore in brokerage fees this financial year. That’s ₹22,850 crore of investor money that could have been invested for greater profits through dividends and capital appreciation. As far as depositories go, their major source of income is through various fees and charges that companies pay them when they are listed.

You might be wondering, “If the brokers go kaput (like my writing skills at 3 am when writing this article), what about the tax revenue the industry generated?” The answer is simple, tax the investors’ increased income from the increased investment corpus. Depositories also earn through brokers by charging various taxes and fees. These charges could be levied at a lower rate on the investors themselves.

Remember the D2C example in the beginning? If this imaginary model is implemented, the same cost reduction benefits can be achieved in the investment domain as well. Investors could pay a minimal platform fee and the relevant taxes (which are currently levied on brokers, and its burden is transferred to the investor through brokerages). The removal of middlemen could reduce the settlement period, which would be beneficial for traders.

Those worried about authoritarian bodies gaining monopolistic control over a department, look at Indian Railways. They are doing the “choo choo” business alone and doing it well! Opportunity for collaborations with private bodies would still stand as the task of establishing and maintaining server infrastructure would be outsourced to private entities.

The End is Near

India’s stock exchange is still in its youth, with a long way to go. There can and will be a lot of changes and developments along the way as the environment reaches maturity. The removal of brokers could also open ways for fractional shareholding in the Indian bourses, as the brokers are currently authorised to act as agents for the investors. Investors directly interacting with the depository institutions could open new avenues for them and, quite possibly, kill the broking industry.

What do you think? Are brokers as integral as they are made out to be? Or should investors exercise autonomy and take their portfolios into their own hands?