NSE directive on client monitoring leaves big brokers uneasy

Back in February 2021, when a technical glitch at the National Stock Exchange halted trading in the equities and derivatives segment, it was brokers who faced investors’ wrath. Angry tweets were directed towards Zerodha, Kotak Securities and 5Paisa, among others as investors were not able to place orders.

“Brokers are the front face. If there’s any interference in clients’ trading and investing activities, we face the brunt of it – our fault or not,” the executive of a top discount broking house in the country said. This reaction comes in light of NSE’s enhanced obligations for qualified stock brokers (QSBs).

On June 2, the exchange asked QSBs to analyse the pattern of trading done by clients and detect any unusual activity. On a monthly basis, QSBs now have to keep track of activity in deep OTM (out of money) contracts where clients are incurring losses. They are also required to regularly interact with retail clients trading only in options.

F&O blues

The exchange’s concern is understandable. After all, 9 out of every 10 equity F&O traders lose money, according to a SEBI study.

“When brokers are activating the F&O segment for a client, they can display some educational content. But clients will not like it if brokers interfere after that. Moreover, a client might be using one broking account for F&O and another for long-term investing. So, it is unfair to assume from a single data set that a client is only trading in derivative products,” said the executive.

Tracking a client’s concentration in any particular scrip is also difficult, the executive added, especially if a promoter’s relatives have accounts with different brokers.

Another ‘enhanced obligation’ that has put QSBs in a fix is close monitoring of the onboarding process including factors such as clients on-boarded from the same location. Not that brokers weren’t doing this earlier. Several unregistered advisors using multiple credentials to log in from the same IP address often used to come under QSBs’ surveillance radar.

“But what if few people living in the same apartment, using the same wi-fi connection, decide to open accounts on the same day,” questions an industry insider. “Should this be flagged off to the exchange?”

Moreover with Personal Data Protection Bill yet to be passed, the grey only gets greyer. Several tech companies have been found guilty of collecting user data and using it for cross-selling opportunities. Brokers, while constantly upping their technical capabilities, now stare at a thin line between preventing fraud and violating data privacy, believe some insiders.

Unbothered…

While QSBs are scratching their heads after reading NSE’s circular, smaller brokers have little to worry about.

“Unlike QSBs, we do not undergo 3-4 audits every year,” said the director of a small broking firm. QSBs, on the other hand, are audited by the depository, exchange and market regulator separately.

In January this year, Sebi issued guidelines to designate certain stock brokers as QSBs, having regard to their size and scale of operations, likely impact on investors and the securities market, as well as governance and service standards.

Following this, 15 firms were identified as QSBs. Zerodha Broking, 5Paisa Capital, HDFC Securities, IIFL Securities, Motilal Financial Services, Kotak Securities, and Sharekhan among others.

Long and short…

QSBs might have the financial muscle to fulfil the enhanced obligations but it definitely adds to the industry’s growing list of concerns, said the executive quoted earlier. With ASBA-like mechanism affecting float income, prohibition on creating bank guarantees using client funds, and now this, brokers say they are staring at a hard future.

“Bottomline, broking fees will go up and investors will be at the receiving end,” said the executive.