Brokerages prod Sebi for grading

Market participants may soon get to know the actual strength of their brokers as large brokerage houses have initiated talks with the Securities and Exchange Board of India (Sebi) to start a process of grading for Indian brokers. The move would not only help investors know the risks involved in dealing with their brokers, but also facilitate assigning open interest (OI) limits for each broker according to their grades in the long run.

Market experts said that a grading process would revive the faith of investors and also attract foreign investors, who are often concerned over intermediation risks.

“Investors are ready to take market risks but not intermediation risks. Grading will become a very powerful communication tool apart from the information on capitalisation and other financial parameters provided by brokerages,” said Anup Bagchi, executive director of ICICI Securities.

“Possibly, broking is the only industry where 100 per cent money is channelised through the broker in advance. It is a highly fragmented market with high intermediary risks but having no way to select the right and quality intermediary. Grading may help resolve these issues,” added Bagchi.

A senior Sebi official said that grading of brokers could be used as a good option, but there was no such regulation or guideline in place at present.

An industry expert close to the development said that grading should be done periodically and cover the end-to-end process. Rating agencies like Crisil and Care could be authorised to carry out this work.

“If there is a formal grading process in place, it will help customers know who they are dealing with,” said Bagchi.

“Parameters like customer education, account opening process, compliance with Know-Your-Customer (KYC) norms, risk management system in terms for margin collection and exposure limits, trade execution process, customers fund and securities management in accordance with guidelines and customer complaint resolution system should be considered while grading a given broker. Grading on each parameter could be on a scale of 1 to 10,” said the expert, who did not wish to be named.

Market players said that one of the fundamental reasons for under-penetration in Indian markets is the lack of faith in intermediation. Trade guarantee funds are mechanisms to address the risk of settlement but not the client-broker dispute.

Grading may help investors become fully aware of the risks involved in participating in a market process through a broker.

Currently, the OI is equally divided among brokers irrespective of their size and reputation. “Grading would encourage groups to hold multiple cards and open ways of consolidation in the industry,” said a senior official at a large private brokerage.

“A formal grading process will help Indian markets boost confidence of institutional clients. Grading may proportionally have an influence on OI limits, which, at present, are assigned regardless of the size of a broker. The grading process will also help in allocating businesses for institutional clients,” said Sudip Bandyopadhyay, Managing Director of Reliance Money.

“Many large brokerages are listed and their quarterly results communicate their strength. Small brokers are mostly unlisted and do not have means to communicate their inherent strengths. Grading would help these small brokers,” said a senior executive at a large bank-owned brokerage house.

In most countries, including the US, such grading systems help the regulators fine-tune the surveillance framework for the markets.

Large players with lower grades have higher oversight. In the absence of such grades, smaller brokers rarely fall in the oversight process. With over 1,000 brokers each at the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), and over 20,000 sub-brokers, a good oversight framework would be critical to give confidence to customers, said sources close to the development.