Direct market access in exchanges will pose higher systemic risk: Brokers

Domestic brokerages say giving direct market access (DMA) to clients and allowing them to directly trade on the exchanges could lead to significantly higher systemic risks.

Since the buzz on DMA floated on the Street this week, share price of the listed brokerage ICICI Securities is down over 15 per cent. Geojit Financial Services is down over 7 per cent, while IIFL Securities and discount broker 5Paisa Capital are down 7.4 per cent and over 18 per cent, respectively.

“If there is a client default, the onus is on the brokerage firm and not on the exchange. If exchanges, as one large entity, were to take such a risk it would be systemic and put everyone participating in the markets at risk on an extremely volatile day (like in 2008),” said Nithin Kamath, co-founder and chief executive officer (CEO) at Zerodha, the country’s largest broking house in terms of active clients.

“One fat-finger trade by a large trader could potentially bring down the entire exchange,” he added.

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Broking houses add that such a move will not be feasible and might not see light of day, at least in the near term. “Taking over the role of a broker would require exchanges to take over several functions. How will exchanges issue contract notes, update clients on their combined margin limits (across exchanges), give them profit and loss and portfolio statement after consolidating their transactions?” asked Dhiraj Relli, managing director and CEO of HDFC Securities. “Also, will exchanges do KYC of clients, open accounts, and will client need to log-in and log-out every time to trade on a different exchange?”

At present, brokerages deposit relevant taxes. Market participants question whether exchanges will take up this role. They will also need to set up customer care operations to handle grievances.

Brokers offer various options to clients to place special orders such as smart order routing, which the client can use to buy or sell the security at the best price on any exchange.

Market experts say expanding functions will raise the cost-burden on exchanges and impact their financials.

At present, brokerages have to undergo inspections by the Securities and Exchange Board of India (Sebi), depositories and exchanges, as the latter also play a regulatory role.

However, the possibility of DMA will make exchanges both the regulator and executioner, raising questions on what would happen in case clients want to escalate their grievances with exchanges.

“It is legally and operationally not feasible for exchanges to be directly servicing millions of investors,” says Jimeet Modi, founder and CEO at Samco Securities.

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Modi said brokerages are required to put in an additional 10 per cent margin with the Clearing Corporation for every client trade. “This makes sure risks are contained and there are no payment defaults,” he said.

Market participants say that Sebi at the most will make direct settlement mandatory. “For instance, exchanges can directly credit securities to the client’s demat account, which is already happening. The regulator can now make it a mandatory across the board,” said senior executive of a broking house.

Even institutional investors using DMA, route their orders through broking houses’ order management and risk-management systems.

“Effectively, exchanges currently have to monitor the risks of only a few thousand broking entities, rather than the clients,” said the head of another broking house.