Direct Market Access (DMA) for retail investors?

July 29, 2020
Rainmatter

Negative news generally gets more views compared to happy news due to the Negativity Bias. Social media went berserk when the rumour broke out about the possibility of stock exchanges offering Direct Market Access (DMA) to retail customers without involving a brokerage firm, implying exchanges functioning as quasi brokers themselves. Several articles were published without understanding the market microstructure and its nuances. And to top it all off, the price of brokerage stocks went down, and exchange stocks went up on this rumour. I thought maybe someone from the industry should clarify, in layman’s terms, why it’s unlikely that the exchanges will deal with retail investors directly, at least in the near future.

Disclaimer: I have a conflict of interest in writing this. 🙂

Technology at Exchanges and the RMS

The core of an exchange is its matching engine — the technology that matches a buy order and a sell order against a bid and ask price to generate a trade. This trade price (LTP) and open orders are streamed to brokers who use this to feed their trading platforms (marketwatch, charts, etc.).

The hardest part of the capital market business though isn’t the matching engine but risk management. This entails ensuring that the person trading has sufficient funds to trade or cover any losses, or enough stocks to give delivery on a sell trade, etc. One question doing the rounds yesterday was “if UPI can do it for payments, why can’t there be a similar structure for trades at the exchanges?” Unlike UPI, where full money is taken from one customer and given to another, every single trade on the exchange carries a risk. Imagine UPI where payment apps or NPCI itself had to take a credit risk on every transaction, could UPI even exist in the current form?

The next logical question would be — what if this system is used only for trades where full money or full security is available in the customer’s account (stock delivery trades)? Well, over 99% of all exchange turnover is non-delivery margin trades—futures, options, and intraday stock—where full money or stock is not involved. However, even in the 1% where there is full money or stock available, there is still a risk. For example, an illiquid stock is trading at Rs. 100, and I place a market order to buy 1000 shares. Before the order is placed, the Risk Management System (RMS) validates if there is Rs. 1L in the account. But by the time order goes through the RMS and hits the exchange, the price may have changed to Rs. 103. The order now will get executed at 103 or Rs. 1.03L worth of stock bought with Rs. 1L in the account, resulting in a shortfall of Rs. 3000. This risk today is borne by the entity facilitating the trade, as the seller is owed Rs. 1.03L, i.e., the broker.

Now consider that you have to do risk management for millions of customers and take that risk on tens of millions of trades daily. And this is not just the risk with delivery trades illustrated above, but also the 99% leveraged trades where the risk is significantly higher by several orders of magnitude. So exchanges around the world delegate client-level risk management to brokers and don’t look at individual clients’ risk. So if Zerodha has 3 million customers, for NSE and BSE, Zerodha is just one entity who has kept funds on behalf of all the customers lying with them on which exchanges allow trading. 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). One fat-finger trade by a large trader could potentially bring down the entire exchange, and with it, all the people trading the market.

The exchanges manage risk in multiple ways. Firstly, to be a member of the exchange, the member/broker has to maintain security deposits, and qualify in terms of credentials. The exchanges then block all new orders from a broker if the total margin utilised is over 90% of what the broker has placed on the exchange. The exchange risk management software has to manage the risk of only a few thousand entities (brokers) instead of millions of customers directly.

So, I don’t know if regulators will allow exchanges to carry such a large systemic risk. Even if they do, I don’t think any exchange in the world has risk management technology that scales to millions of customers right now. It is like exchanges having millions of brokers registered directly with them. This technology has to be built first, which in itself is going to be a herculean task.

Here is an example – On April 20th, 2020, Crude Oil prices closed at a negative price. The brokerage industry in India lost upwards of Rs 330 crores in client defaults. If there were no brokerage firms, this loss of Rs 330 crores instead of being across multiple brokers would have been on Multi commodity exchange (MCX). While MCX has networth of over Rs 1500 crores, it may not be all in liquid instruments, hence meaning that this incident could have put the exchange and hence everyone else who trades on MCX at risk. Click here to read more on the incident. 

How does DMA currently work for institutions then?

There is a misconception that the current DMA available for institutions somehow gives them access to place orders directly on the exchange. This is incorrect. The order still goes through a broker’s Order Management System (OMS) and RMS. The only difference is that in DMA, no one at the broker’s RMS team or dealing team can modify or cancel any orders placed. If there is a risk management issue, the broker will have to call the institution and ask them to modify or cancel orders, exit positions, or add more funds.

Can this DMA which is currently offered only to institutions be made available to HNIs or large retail investors? It is possible, maybe something might be at work and also maybe what created the rumour, which led to what I think is fake news, and caused broking stocks to fall while exchange stocks rose. But, the current way of offering DMA to retail involves a brokerage firm.

Broking is complex. It is not just order placement

  • The reason for the success of our business isn’t just allowing order placement on the exchange at low cost. It’s the user interface, user experience, all the different order types, charting, mobile and web apps, analytics, reporting, and more. For example, something that sounds as simple as calculating the “buy average” price of a stock holding factoring in FIFO, corporate actions, stocks which are transferred in and out, is a mammoth task.
  • Stock markets are complex for retail investors. The broking industry has tens of thousands of people employed to help cater to customer queries. Even the most experienced traders have queries. For example, this frequently asked question on why a trade is executed but not visible on the chart. The query usually starts with the customer calling us frauds until he or she understands why.
  • Checks to prevent money laundering, while onboarding and continuously
  • Handling short delivery of stocks, when you buy stocks and don’t receive delivery.
  • Handling fund transfers and withdrawals across millions of bank accounts.
  • Handling the trade process, reconciling millions of trades daily, sending out contract notes, etc.
  • And of course, never-ending non-critical customer requirements like 25 or 75 min candles, dark mode, trading from charts etc.
  • And the list goes on.
  • Can an exchange do all of this? In theory, it could. But could it do it efficiently at scale for millions of customers? Building each one of these processes can take a long time.

Exchange as a regulator; self-regulation?

Exchanges in India act as first-level regulators. That is, they monitor all brokerage firms and ensure they adhere to the prevalent rules and regulations, and also hear customer complaints and act as arbitrators. But, imagine exchanges themselves starting to directly deal with customers. Who is going to regulate the exchanges and who is going to handle grievances? This would not be possible without a complete change in the Indian capital market structure.

Stockbroking is an extremely complex business that carries infinite risk in terms of compliance, operations, and technology. Stock brokers mitigate risk which otherwise can be systemic. Stock broking isn’t just another middleman like in real estate or agriculture or selling mutual funds who can be easily replaced, if at all that is even possible.

Nithin Kamath

CEO @ Zerodha and partnering startups through Rainmatter to help grow and improve the capital market ecosystem in India. Love playing poker, basketball, and guitar. @Nithin0dha on Twitter.

32 comments

  1. Ajay Gupta says:

    Hello sir, we are highly concerned about the margin upfront collection. We have few questions to ask-}
    1) SEBI circular mentioned that the rule will come into action in December 2020 whereas there is a news that it will apply from august 1 2020.

    2) will there be any representation from broker’s side to present more logical framework to allow decent leverage like zerodha provide on Mis orders.

    Please clarify
    Thank you
    Ajay gupta ( proud zerodha user)

  2. Ravi Shankar says:

    If regulators are doing away with margin completely from next year and there won’t be any difference in margins being provided to brokers by exchanges and from brokers to clients then theoretically brokers become irrelevant … The technological platform is the only difference maker …exchanges can always invest … Demat shares are anyways handled by CDSL and NDSL

    • Like I mentioned in the post above, equity delivery is just 1% of overall exchange volumes. Everything else is leveraged products.

      • Samir Gupta says:

        if DMA comes then it will create a choice to retailers. Brokers have to evolve otherwise time will teach you hard lessons. A good broker with better products will survive.
        Zerodha brought low brokerage to this industry, but not sufficient as other brokers have started offering very good products and services today.

        One example where Zerodha fails- you offer discount brokerage in derivative and equity trading, but when it comes to derivative delivery or physical settlement, you charge very hefty amount. I think DMA will help retail investors in savings 🙂 hope Zerodha will evolve and rationalise derivative Physical delivery settlement Charges 🙂

  3. suneel says:

    IMHO, I think except enabling margin trading, everything else can be done by Exchanges with the current advances in technology. Margin trading would require a significant amount of risk capital commitment, and that’s the hindrance, else even that’s not an unachievable task.

  4. Nilesh Joshi says:

    Excellent and well articulated Nithin.

    Please go thru the below link of London Stock Exchange (incase you have not seen it earlier)

    https://www.londonstockexchange.com/personal-investing/tools/direct-market-access?lang=en

  5. Govinda Chate says:

    My biggest concern is on short selling margins would be blocked.. Even if you bring in lacs just to trade thousands it will still not be enough. Because once u short your margin is blocked for 2days. Meaning your bet can’t go wrong other wise wait for 2days to realise the margine on short. Normal intra day trader would take 5-6 trades a day I’m just considering intra day and not even scalpers.. Scalping would be like banned.. If u wanna scalp for rs1000 position bring in lacks to place

  6. Vikram A Rao says:

    Hello Nithin,

    Very well written article, SEBI should focus on bigger issues. DMA is not an impossible task can be achieved with the current technology however why they want to implement DMA. This will result in Job loss in broking industry, there are some fine brokers with world class platforms (there are downtime with every broker and I am totally fine with it) what about their investments in people, technology. Even if the DMA gets implemented I don’t want to trade directly on exchanges. I would prefer to place orders from my brokers terminal.

    Regards
    Vikram

  7. Shreyas Chavan says:

    I will be thankful to sebi if they start DMA. Some people said it is very hard to handle all Million of customer but I ask government has also know what should be problem they will face in future and how to eliminate them. Government have enough money to buy many companies like zerodha and they know how to deal with these. If some jobs are going then new jobs are also generating. And all you know that brockers are apply too many hidden taxes which could be eliminated by DMA. Charges are applied by brockers are horribly high.
    Eg. If you hold a share for more than 4 days you will be charged 14 rs per share whether you have profit or loss. These is very bad thing about brockers which always apply hidden charges. Sebi has enough infrastructure for handling customer

    • Rahul bajaj says:

      Yes i agree with u bro , like if u have a bunch of stocks in ur portfolio , and u are a small investor , then if u sell all you have to pay like rs 14 X no of different stocks . So eventually we are left with very little amount . And sebi should also ban penny stocks as many people are loosing money in them because of penny stock being advertised in news and youtube as gold and diamonds and when we buy them operator is actually booking profit there .

      • Shreyas Chavan says:

        Bro listen, last year I bought 200 share of each for 29 rs which cost 5800 rs. After 9 month it price for each share goes to 47 rs. And then i calculate price it come out 9400. It give me profit of 18 rs per share which is very good performance.
        Then I decided to sell these share for as it give me so much profit . Then I go on zerodha app then proceed to sell and it get sold . After that I see only I have profit of only 800 rs and zerodha dp charge it 14 * 200 units = 2800 rs which is almost 3.5 times my profit. From my example , it is very good if DMA is offered to retailers and retailers are very happy if these DMA will apply which may come in next year. As you see bse share goes 9% high after these news of DMA come in market. So it will very good if brockers were removed by sebi new rule. Most people are not invest in share market becoz these hidden charges , demat account, brockers fees,if these will Eliminated like mutual fund it will be biggest gift to all of us

        • Samar says:

          You are mistaken here buddy…. I have been doing investing since a long time…. The charges by broker on delivery is 0 and charges which was put across is charged by cdsl and it is based on per script not the number of shares

  8. Kishor says:

    Hello Nithin sir.
    I have suggestion regarding Sebi new margin rule not to allow trade within (T+2) . If possible please come up with overdraft facility for Zerodha customer.I think this solve problem of customer and broker.
    Regards
    Kishor

  9. Anmol Shah says:

    Hi,

    If I am correct, new upfront margin collection framework in Equity cash segment will be in effect from 1st August, 2020 ?

    I have following questions :-

    1. Do we will need to provide margin for selling stock in which is already in our Zerodha’s Demat Account ( irrespective whether PoA is provided or not ) ?

    2. Suppose I buy any stock today with 100% fund on delivery basis and would like to sell it the very next trading day. Will I require to provide margin while selling the stock on T+1 day because it is not settled demat account ? Also, if I buy another stock on T+1 day with the sale proceed of previous stock will there be margin shortage then ?

    3. Suppose I already held (x) no. of shares of company A in Zerodha’s demat account. On T day, I buy (y) no. of shares on same the company A. Will there be any margin requirements if I sell (x+y) no. of shares of company A on T + 1 day.

    @nithin0dha, If you could explain I will be more than happy

  10. Giridhar says:

    It should be permitted for cash and delivery transaction. The risk you wrote about wrt slippage in the pricing is already covered as the shares can be sold to recover. RMs is primarily for intraday transactions where there is a margin interplay.
    Just like direct plans, direct PM’s the process of disintermediation should apply to trades also especially delivery based. That is the mantra of discount brokers and it is important that the brokers make efforts to take responsibility of their advice instead of only pricing the IT infrastructure and ui. But no one wants to move ahead and take the risk of owing advice. If you look at Schwab they have moved ahead with advice ( fiduciary standards) instead of just milking distribution and ui ux investment s.

  11. Pawan Kalyan says:

    Hey Sir,

    Can you give us any updates regarding when we as an individual investors can have access to the foreign stock market (NYSE,etc) through Zerodha platform?

  12. Rahul bajaj says:

    I think dma is a great for investors because if bad news comes then market falls like hell because of intraday traders who short the market taking a lot of levrage , at least there will be less valatility for investors and i think dma should be alllwed for equity only and not for commodity .

  13. Ajeet Chaurasiya says:

    New margin system will decrease the revenue of all the participants whether investors, brokers, or exchanges
    And DMA looks very complex in current scenario
    Lets see what happens😁😁

  14. Ravi Patlegar says:

    Nithin, thanks for participating in conversation here.
    Still I do not agree with your statement as bad news. If something is feasible and implementation is possible for Direct Market Access, it is always a good news for customers. I am sure government is capable and find solution here.

    I have bigger concern on quality of support we get from brokers and this where we are much worried on the side. I am following up with your team and directly loaded my mail to you.
    There are good amount of improvements possible onto kite tools, but unfortunately I just get response we are taking your feedback with closure of ticket without employees consent.

    Broker sites will be more meaningful if they understand customers need and able to help them.
    Like for example, senior citizen sometimes have questions on the brokerage parts and might need to have these calculators handy on tool, similarly direct call tab on tab to customer care.

    Now recently many times we have to wait on fir more than 1/2 hour to get someone onboard to address our call.

    Please do resolve these issues to upfront to keep customers happy here.

  15. Vivek says:

    @nithin why doesn’t zerodha go “upstream” by starting an exchange, clearing house etc? Is it not allowed?

  16. Dinesh Singh says:

    Very informative article..thanks alot RM

  17. Taran says:

    DMA is a great move for individual traders than it is for investors. If I can save on brokerage I may be required to forego the leverage offered by the brokers. But the leverage is a double edged sword, it can multiply profit & loss both. This will discipline me to control my greed and will thus be helpful in building wealth slowly.

  18. KAMLESH says:

    its good that discount brokers are capturing market and providing online platform for the traders, they develop traders only and not providing long term investment advisory as to generate maximum revenue.how ever regulator turning blind eye for the mistake or default like emkay global or karvy. please note that in case of default so called discount brokers, total system will broken as at discount brokers the concept of know your client is missing as, know your client is only documentation. The stock broking profession is like medical profession where stock broker knows client family back ground and if client may trade excess the stock broker shall ask him to trade in limit as per the family profile of the client. In new scenario sebi and exchanges are taking proud of highest volume and broker only knows how to generate maximum profit by allowing client to trade.clients may have to sell his entire wealth due to unlimited trades of client is not look out of brokers, exchanges or regulators.

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