Europe's new market rules to pinch Rs 200-billion Indian broking industry

New norms designed to improve transparency, boost investor protection

The nearly Rs 200-billion Indian broking industry is feeling the heat and its roots can be traced all the way to Europe.

The European Union (EU) has introduced new rules, which are already taking a bite into the revenues. This, in turn, is changing how research and execution services are offered to some of India’s largest foreign investors. The resulting pressure on earnings for the domestic market is likely to mirror the tumult that has been seen across the world, according to experts.

EU’s Markets in Financial Instruments Directive-II (MiFI-II) rules are designed to improve transparency and boost investor protection safeguards.

The new regime came into effect in January 2018. Among the provisions is a need to unbundle research and broking functions. Earlier, institutions typically paid one amount which would cover both. Now, those based out of Europe have to pay separately for each.

At least a fifth of the foreign portfolio investors’ assets under custody in India are from EU countries.

The United Kingdom, Luxembourg, Ireland and Netherlands collectively account for Rs 5.7 trilllion in Indian equity market investments, according to depository data as of April 2018.  

The new regime can extend beyond these nations.

Charanjit Attra, partner at financial accounting advisory services EY India, said the rules requiring separate payments apply to all institutions headquartered in the EU or with operations there.

“This is posing a big challenge to brokers who are servicing them across the globe. Indian brokers would also have to follow a separate pricing strategy for European clients,” he said.

“Asset managers have to separate broking and research payments. There has been an industry-wide drop in broking yields because of it. Some of it is compensated through research income, but not all of it,” said Vikas Khemani, president & chief executive officer at Edelweiss Securities.

While the move is only beginning to make its impact in India, it has already caused major changes elsewhere in the world. Asset managers are said to be cutting research budgets. Salaries are said to be heading downward.

The Financial Times has predicted that the number of analysts will halve.

Reuters reported that brokers are picking companies in which they can offer an edge in terms of research. This resulted in fewer analysts tracking lesser known companies.

The Wall Street Journal reported on difficulties in pricing research reports which resulted in a tug of war between analysts and asset managers.

In India, experts are watching if this will turn into a foreign versus domestic brokerage war.

Some argue that domestic brokers, with their lower cost, are better placed to absorb the hit in revenues. Others argue that foreign brokers may have relationships and investments in technology which place them in a better position. The only agreement seems to be about the inevitability of the shift in revenues towards stronger players, whether domestic or foreign.

The research arm of rating agency ICRA has predicted broking revenues of Rs 190-200 billion for FY19.

Broking houses that tend to have more foreign investors as clients would be more affected, said Samriddhi Chowdhary, assistant vice-president at ICRA.

New rules of the game

• New European regulations became effective in January
• They require separation of research and execution payments
• Have caused a tumult elsewhere in the world
• Revenues have fallen, research budgets have been cut
• Salaries are affected, analysts have lost jobs 
• Companies receiving less coverage 
• Impact on India is relatively recent
• The EU accounts for a fifth of India's foreign equity assets
• Pressure on revenues already being felt