Brokerages increase exposure to derivatives

With client activity on a decline, brokerages are sitting idle on the working capital that would have typically gone into infrastructure expansion during a bull run. As the markets stay range-bound and business expansion plans are pushed onto the backburner, brokerages have found a new avenue for generating better yields on their cash reserves — derivatives.

According to the Securities and Exchange Board of India’s latest report on the derivatives segment, the share of proprietary trading in the futures and options segment was more than 34 per cent during April-June. This was a rise of more than four per cent over the first three months of this calendar year.

“While client trading decreased (5.3 per cent), both proprietary (4.4 per cent) and foreign institutional investor (one per cent) trading increased in this quarter, compared to the previous quarter,” noted the report. The report put the share of client trading in the F&O segment at 54.53 per cent. Meanwhile, proprietary trading constituted 34.32 per cent and that of foreign institutional investors (FIIs) was pegged at 11.15 per cent.

Market experts attributed the trend primarily to the low “activity ratio” that put more free cash on the books of brokerages. As a result, brokerages are using the cash for treasury operations by trading in derivatives or using it for arbitrage operations.

“Unlike last year, the activity ratio this year has been quite low, with most categories of investors staying away from the market. This has left brokerages with free cash reserves or working capital,” said Dinesh Thakkar, chairman and managing director, Angel Broking. “Brokerages are using this free capital for treasury operations by doing arbitrage trades or trading in derivatives. This increases the yield on the cash.”

The share of proprietary trading in the derivatives segment, interestingly, appears to be at the highest levels in the last couple of years. Since the beginning of 2008, the average share of proprietary trading has been hovering around 30-31 per cent for most months. For instance, between January and March 2009, proprietary trading accounted for 31.21 per cent of the total volume. The average for the quarter ended March 31, 2010, was pegged at 29.93 per cent. Meanwhile, in the last two years, the share of client trading has fallen consistently from over 60 per cent to 55 per cent.

Motilal Oswal Financial Services CMD, Motilal Oswal, feels arbitrage trading in the derivatives segment of brokerages has risen when activity from clients and institutional investors is on the downslide. “The return on capital is low if left idle. The best way to deploy money is to use it in arbitrage opportunities,” he said.