After receiving a lukewarm response to the direct market access (DMA) facility provided by the regulators to trade directly in the markets, brokerages have started to see increased participation and are gearing up to offer services to increase volumes through this route.

Leading domestic brokerages like KR Choksey Securities, Almondz Global Capital Markets, Antique Stock Broking, India Infoline and Karvy Stock Broking among others are in the process of offering DMA facility to their institutional clients that enables them to directly place trade order in the exchange trading platform through broker’s infrastructure without manual intervention by the broker.

And the key strategy here is to offer superior services through ‘quant-based’ investment solutions. This ‘rule-based’ investment style is slowly catching up in India. Complex mathematical algorithms are created to track market movements and take investment decisions rather than rely on individual fund managers.

Globally asset mangers, pension funds and hedge funds use DMA facility mainly to execute algorithm trading or program based trading in highly liquid markets. Such programme-based trading has caught fancy in developed Western markets where institutions rely on predetermined and back-tested models to calculate trading strategies including the timing, price and volume of different trades. Back testing involves using the models in previously occurred situation. These models are also tested for forward looking scenarios that could emerge and tightened for optimism.

According to industry experts such trades accounts for nearly 25% of the total volume in the developed markets. Recently, Sopawadee Lertmanaschai, chief market officer for markets and post trade services at the Stock Exchange of Thailand, which is encouraging the use of ‘rule-based’ or programmed trading methods to help support market liquidity said in a presentation, “In 2008, such programmes on the Singapore Stock Exchange accounted for 15% of the total value of trades; for the Korea Stock Exchange, the figure was 13.5% while for the Tokyo Stock Exchange, it was 9.3%.”

However, India is yet to catch with global markets in DMA trade. Though no official figures are available, market participants estimate the total volume of trade done by institutions through DMA in Indian capital market to be roughly in the range of 5% to 7% of their total traded volume.

Vipul Sanghvi, president – institutional equity sales, Religare Capital Markets, which is already offering this facility, said, “When compared with other developed markets, the volume of trade through DMA in India is much less. But it is a gradual process and would take off as the market develops. This product is most suitable for programming trade environment.”

With the focus shifting towards emerging markets equities after the recent credit market crisis, brokerages say that increasing number of institutional investors has now started enquiring about this service and in order to retain their clients, it has now become a necessity to offer DMA facility.

“One of our domestic institutional investor based out of Mumbai has completely migrated to DMA facility and has stopped dealing with those brokers who doesn’t offer this service,” said Harjit Singh Sethi, country head, institutional equity broking, Almondz Global Securities, which is awaiting stock exchange approval for launching this product. “Few of our domestic and overseas institutional clients are looking forward to use this service. We are desperately waiting to get license from the exchange to provide this facility to our institutional clients.”

DMA was permitted in the Indian stock market by the regulator in April 2008, when it issued the operational guidelines. The move was aimed to give clients direct control over their orders that would help in faster execution of orders, reduce risk of errors associated with manual order entry, increase transparency and liquidity in the market and lower impact cost for large orders.

But one key challenge for the immediate growth of trade through DMA was the lack of depth in the Indian market. Currently over 92% of trading in the Indian market is concentrated on top 100 large cap companies with 60% of them getting concentrated exclusively on the leading 25 listed companies. The increased impact cost in illiquid stocks presents the biggest challenge. Impact cost comes into play when large institutional investors either buy or sell stocks. It is the cost that the buyer or seller has to pay by the means of a change in price simply because they transacted. A mid- or small-cap company’s price fluctuates immediately when a large institution decides to sell or buy.

“Liquidity is a key constraint in India. Once the depth of the market increases and liquidity expands beyond the top 50 or 100 stocks in India, we will see huge growth in trade through DMA facility,” said Anish Jhaveri, CEO, Antique Stock Broking, which has recently received the exchange approval for providing DMA facility to its institutional clients. He also mentions that the Korean stock exchanges have set up infrastructure and created liquidity in a very efficient manner so as to facilitate DMA based trading.

Apart from bringing markets more closer to the end user through direct interface with the exchange trading mechanism, DMA trade over a period of time is also expected to reduce the possibilities of leakages and front running activities. When an institutional investor places large orders either ‘buy’ or ‘sell’ through different brokers, street sentiments also gets swayed in line with those trades as the identity of the buyer and seller is known.

“It makes sense for those investors who execute large trades that have the potential to move the market. The complete confidentiality at the time of trade execution will help in minimising its impact,” feels Sashi Krishnan, CIO, Bajaj Allianz Life Insurance.

But the advent of DMA will also now require the brokerages to revisit their business models as shifting of trade execution from broker to its institutional clients will alter the revenue stream of brokerages.

Since this is early days we will have to wait and see how the cost of transaction changes. If the commission or brokerage payable gets reduced drastically, brokers will feel its pressure on their operating margins and only large players will be able to sustain in the business. This would ultimately pave the way for consolidation of domestic broking industry.