At Yahoo: Taking Stock of Commissions

I write at Yahoo! about Taking Stock of Commissions:

On May 1, 1975, fixed commissions were abolished on Wall Street. From an era of charging fixed commissions on a per-share or percentage basis, the model moved to "negotiated" commissions - charge anything they wanted. The day was called "Mayday" - an indication of the distress the industry felt about losing the profitability of cartelized price control. On October 27, 1986, the same thing happened in the UK, and the day was called the "Big Bang Day". Losing fixed commissions seems equivalent, in the industry, to Armageddon; but in both the cases above, after a brief hiatus, the UK and US have only benefited with the reform. They are now the largest markets in the world.

India has only started down this route - let's see where the primary investment avenues lie with respect to commissions.

Buying Shares

In India, stock broker commissions are not fixed, but they are strangely convoluted. When you buy a stock, you usually get charged a percentage of the trade value - that is, quantity multiplied by the share price, usually between 0.1% and 0.5%. And that's just brokerage. My contract note - a sheet that has everything that's charged to me for each trade - has all these additional charges:

  • Service tax and Cess: a 10.3% tax on the brokerage, paid to the government.
  • Securities Transaction Tax (STT) : 0.25% of the trade value, only applicable when I sell, goes to the government.
  • Stamp Duty, Turnover Charges: Regulatory fees payable to the state, exchange or SEBI, usually a percentage of trade value - about 0.004%. This is so small they might only quote it as "400 rupees per crore".

In addition, some brokers charge a demat fee of about Rs. 15 per transaction and annual demat or account charges. To complicate matters further, brokerage, STT and exchange fees are different for intraday trading (buying and selling within the day), futures and options. Specifically in options, the brokerage is ridiculously high - upto 2.5% of premium paid or received with a minimum "per-lot" charge, usually Rs. 50 or so.

Trading then might cost more the advertised brokerage shows, and usually shocks first-time investors. But one question has to be asked - just why are commissions a percentage of trade value?

A long time ago, trading was done in the open-outcry format, where you found a crowd of (mostly) men in the well of a stock exchange, making strange hand signals and recording trades. That, anyone will agree, involves more work for more shares and proportionate fees are acceptable. All stock trading is electronic now, and the hard work of making strange signals is now the responsibility of silicon, not a carbon based life form. Then why should selling 1000 shares cost more than selling 10, especially when it comes to brokerage paid (one might understand STT or exchange fees)? Why is the "pay-per-trade" model, so prevalent in the US today, not popular among brokers to get market-share?

Some of the current efforts are half-baked - like a Rs. 5,000 for trades upto Rs. 7.5 crore, which is just another percentage brokerage concept, or a Rs. 1000 per month but the trading tools are unreliable. Others are in their infancy. (Disclosure: I'm advising a company offering fixed pay-per-trade rates.)

In order to move in this direction, technology needs to catch up at the broker and retail ends. You have absolutely fantastic trading terminals at brokerages in the US, but very little innovation seems to have happened in the area in India. The big players in this space in India are partly owned by companies who are owners of the stock exchanges themselves (NSE and MCX, for instance) and brokers have invested precious little in technology that lets investors gather data and make their own decisions. Lower commissions from competition might actually prompt innovation.

(Read the entire article)

Comments much appreciated. Yes, I posted two in quick succession – I was really late on the last one!

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