The country’s largest stockbroker Zerodha has reached out to its customers stating that it has ringfenced itself from any defaults in the light of the controversy surrounding Karvy Stock Broking.
In a blog post, Zerodha’s founder and CEO Nithin Kamath said most financial irregularities have debt as the main catalyst, while his company has always been zero-debt right from the beginning. “We have done no margin funding till date and when we start, we will have no legacy issues in following the SEBI June 2019 circular that requires funding to be only through own funds.”
Stating that the SEBI order against Karvy has come as a shock to everyone in the capital market ecosystem, Kamath also said that Zerodha does not keep client securities in its pool account. All client securities are always in their respective demats. “We have one single brokerage deal for all our customers. We don’t distinguish HNIs from others. We have never advised or sold any product promising returns. The only thing we do as a business is to offer execution platforms for someone who has an intent to buy/sell. No conflict of interest.”
He also pointed out that by having a single deal for all, its operational risks are reduced significantly. “We have never had issues in terms of securities not being credited to our clients’ demat accounts, securities being moved out without authorisation, or with client fund payouts. Our own funds are over 25 per cent of all our client funds put together. This has to be among the highest in the industry in terms of skin in the game, all accrued from organic revenue.”
SEBI’s strong move
He explained in his blog that a new, strong regulation was brought in June 2019 which barred brokers from pledging client securities to other NBFCs. Many brokerage firms until then used this route to do their margin funding business. Essentially, when a broker allows clients to buy more stocks than the money in their accounts for many days, the broker, instead of using their own capital to fund the transaction, will pledge the client’s security which is unpaid for, with another NBFC and in turn utilise those funds. This not only means higher brokerage income as the trade size is bigger, but also an interest income — the differential of the rate charged by the NBFC and what is charged to the client.
However, starting June, brokers have to put their own capital, which means they can lend only their own free cash, which is not much for most brokerage firms. The regulation also required all brokers to unwind any such already existing positions with NBFCs by August 31, 2019, which meant that the broker had to return the funds to the NBFC and then release the pledge on the shares. This has affected several brokers, especially those whose business model revolved around margin funding. As Zerodha has never done margin funding, this regulation does not affect the company, Kamath said.