There seems to be a pick-up in the illegal business of ‘renting out’ proprietary (prop) accounts, because traders are finding it hard to make profit on a small capital in a low-volatility market and with the failure of previously successful strategies.
The market regulator has increased regulatory scrutiny over the illegal practice of brokerages giving retail traders access to their proprietary accounts--which offers higher leverage and comes with zero brokerage--for a fee. But the practice seems to be flourishing anyway.
This ‘renting out’ of accounts, which works like a multi-level marketing network, is delivering eye-watering profits, even to the lowest rung. While brokers have rented out their prop accounts to traders, these ‘tenant’ traders have further sublet their ‘credit limits’ on the prop accounts to others and are charging a tidy sum for doing so. These ‘tenant’ traders, who work as sort of sub-brokers and are called ‘leaders’ in insider parlance, can make a few crores a month from this, charging even Rs 7-8 lakh a month per client.
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There is a rise in ‘best-trader’ competitions, with the winners given funds to be managed in prop accounts, and market insiders believe this is simply a way to advertise this business.
Who can have one?
Brokerages have accounts through which they trade their own money, which are called prop books or informally called prop accounts.
Prop accounts of brokerages offer higher leverage and don’t attract brokerage charges, because transactions are done directly with the exchange. “To a person who trades heavily, these are big advantages,” said a market insider.
And, these advantages are looking particularly attractive today, now that market volatility is subdued at 11.48 (July 21) .
While highly volatile markets are risky, traders like them for the possibility of making big profits. With volatility trending downwards from last September and falling nearly 9 points since then, traders are looking for new ways to improve their gains.
“We are in a historically low volatility regime, therefore risk is priced low,” said a veteran algo trader.
Also, there is a lot of ‘crowding’ in some of the previously successful strategies and therefore the “edge” that a trader has is lost.
“There has been a huge influx of traders in VRP (volatility risk premium strategy) and the returns have come down. With leverage, even these small returns could mean big money,” the trader explained.
Since high leverage isn’t available anymore to retail traders after the 100 percent upfront margin collection rule, these traders approach a broker for access to the prop account.
But brokers don’t rent out to everyone. They only do so with people who have high capital. The brokers ask the retail traders to have these ‘leaders’ share their ‘credit limit’ (think of it like a rented apartment) with them for a price. That is, if the broker has allowed a ‘leader’ to access Rs 10 crore in the prop account, the retail trader can approach the ‘leader’ for a portion of that for a fee or a percentage of profits made.
In the books, all these traders may be shown as various people hired by the broker to manage their prop account.
Said a market insider, who did not want to be named, “People who use prop accounts are mostly algo traders with a back-tested strategy. All they need is to scalp 1-2 percent on expiry day.”
“If there is a retail trader with an amazing trading strategy, with amazing risk-reward and very less drawdown but it gives only 1-2 percent a day… and most strategies only give so much,” he added.
If this retail trader has Rs 10 lakh, then they can make Rs 10,000 a week or Rs 8,000 to Rs 9,000 a week after all the charges, including brokerages and taxes. But if the same trader uses the prop desk, then they get 5x leverage or can take positions worth Rs 50 lakh, and that means the possibility of Rs 50,000 weekly profits.
That’s a big difference.
“This is the reason why people like prop desks,” said the insider.
Legal consequences
If a prop account owner is found to be sub-letting the account, it can lead to the suspension of the account and there will be penalties imposed on the account holder, said Sonam Chandwani, Managing Partner of KS Legal and Associates.
But it is a very lucrative market and account owners are willing to risk it for a hefty fee.
Market sources inform Moneycontrol that the fee charged can be up to Rs 8 lakh a month per trader, with some prop account owners renting it out to as many as 80 traders.
An entity can have multiple prop accounts with different brokers. According to regulations, prop accounts can be operated only from one location. If someone wants to operate from multiple locations, then he/she has to apply separately for this, citing reasons for the same.
Cashing out
To take out the profits earned, the retail investor and the prop account owner have various arrangements.
“The prop account owner or the leader will either give the profits in money, or they will show the trader and his/her relatives as employees and pay all of them a salary that is just below the taxable limit or they will show the trader as a vendor company and the trader will raise a bill just below Rs 20 lakh, so as not to pay GST,” said an insider.
The trades made by each retailer are tracked — to determine profits and losses — through account IDs they use to access the prop account.
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