Working of Stock Broking Firm

Stock Broker

As seen earlier, According to Rule 2 (e) of SEBI (Stock Brokers and Sub brokers)

Rules, 1992, a Stock Broker means a registered member of a recognized stock exchange. A

broker is an intermediary who arranges to buy and sell securities on behalf of clients (the buyer

and the seller). No stockbroker is allowed to buy, sell or deal in securities, unless he or she holds

a certificate of registration granted by SEBI. The constitution of a broking firm may be a

Proprietary Concern, a Partnership firm or a Corporate.

BUSINESS

Over a period of time RSL has recorded a healthy growing rate both in business volume and

profitability as it only the major players in this line of business. The business thrust has mainly in

the development of business from Financial Institutions, Mutual Funds and Corporate.

OPERATIONS

The operations of the company are broadly organized among the following functions.

1. Research & Analysis

This group is focused on doing stock picks and periodical scrip/ Segment specific research.

They provide the best of analysis in the industry and are valued by both our institutional and

Retail Clients

2. Marketing

This group is focused on tracking potential business opportunity and converting them into

business relationships. Evaluation the need of the clients and tailoring products to the meet

there specific requirements help the company to build lasting relationship.

3. Dealing

Enabling the clients to procure the best rates on their transactions is the core function of this

group.

4. Back office

This group ensures timely delivery of securities traded, operation matters with stock

exchange, statutory compliance, handling tasks like pay-in, pay-out, etc. This section is fully

automated to enable the staff to focus on the technicalities of securities trading and is manned

by professionals having long experience in the field.

Departments in Stock Broking Firm

(A) Central Depository Services Ltd (CDSL) Department

CDSL Department

Demat Account Dematerialization & Transmission Settlement

Opening Rematerialization & Nomination of Trade

(B) Compliance Department

Compliance Department

Reg. Of Client Reg. of Sub Broker

Individual Non-individual

Joint Stock Co. Partnership firm Sole Proprietor

(C) Dealing Department

Dealing Department

Buying Securities Selling Securities

Entering Order Order Order

Orders Modification Cancellation Matching

(D) Settlement Department

Settlement Department

Pay In Of Pay Out Of Pay In Pay Out

Securities Securities Of Funds Of Funds

(E) Risk Management Department / Surveillance Department

Risk Management Department

Capital On Line Off Line Margin Circuit

Adequacy Monitoring Monitoring Requirements Filters

RISKS INVOLVED IN A STOCK BROKING FIRM

A stock broker has to deal with various risks while dealing with its sub brokers, clients etc. Due

to the high volatility of the market broker is always exposed to the risks. The various risks borne

by a broker can be classified as under.

Risks in broking firms

Market Financial Credit Liquidity Operational

Risks Risks Risks Risks Risks

(1) MARKET RISKS

Market risks are the risks which cause due to the high volatility of market and value of scrip’s.

These risks arise due to adverse market rate movement’s i.e. foreign exchange rate, interest rates,

commodity prices and equity prices. The value of investments may decline over a given time

period simply because of economic changes or other events that impact large portions of the

market. Proper asset allocation and diversification can protect against market risk.

(2) FINANCIAL RISKS

Financial risk is the risk that a company will not have adequate cash flow to meet the financial

obligations. Financial risk means fear of loss of money, which is the biggest risk faced by a

broking firm. Financial risk in respect of broking firm can be of two types firstly loss of income

i.e. brokerage secondly loss of capital. It has a risk that it will go out of funds because of non-

payment by the clients, sub brokers etc.

(3) CREDIT RISKS

Credit risk is the risk that the counter party of financial transaction will fail to perform according

to the terms and conditions of the contract, thus causing the other party to suffer a financial loss.

Credit risk is the risk of loss due to a debtor's non-payment of a loan or non-fulfilment of terms

and conditions of contract. Credit risk is often due to bankruptcy or insolvency of the counter

party which results in non-payment of dues.

(4) LIQUIDITY RISK

Liquidity risk is a risk which arises from the difficulty of selling an asset and realizing the money

of it. Market liquidity is the risk that a financial instrument cannot be sold quickly at a price,

which equates to their market value.

An investment may sometimes need to be sold quickly. Unfortunately, an insufficient secondary

market may prevent the liquidation or limit the funds that can be generated from the asset. Some

assets are highly liquid and have low liquidity risk (such as stock of a publicly traded company),

while other assets are highly illiquid and have high liquidity risk (such as a house).

(5) OPERATIONAL RISKS

Operational risks are explained as Risk of loss arising due to procedure errors, omission or

failure of internal control system. These risks are defined as ‘The risk of loss resulting from

inadequate or failed internal processes, people and systems or from external events.’ An

operational risk is a risk arising from execution of a company's business functions. As such, it is

a very broad concept including fraud risks, legal risks, physical or environmental risks, etc.

Operational risks are very common risks, which are found almost in every organization. All the

organizations face the risks that their activities and processes may be disrupted unexpectedly or

fail and this will stop the functioning of organization. Such events may cause an organization

certain problems like-

Direct financial losses, which arise from failing to meet an obligation (e.g. penalty

interest payments or restitution loss).

Direct financial losses, attributable to an absence of income (e.g. loss of sales, transaction

fees, direct fees or commission)

Statutory or regulatory penalties resulting to revocation of licenses.

Opportunity costs, arising from adverse publicity, being unable to trade or because of

processing delays, backlogs, and poor customer service delivery or poor product or

service quality.

In stock broking firms the operational risks are found at various levels of departments. They are

as follows.

Operational Risks

CDSL Compliance Dealing Settlement Risk Management

Department Department Department Department Department

WAYS TO DEAL WITH RISK

Ways to deal with Risk

Avoid Retain Reduce Transfer

(A) AVOID THE RISK

Avoidance of risk Includes not performing an activity that could carry risk. Avoidance may seem

the answer to all risks, but avoiding risks also means losing out on the potential gain that

accepting the risk may have allowed. Not entering a business to avoid the risk of loss also avoids

the possibility of earning profits.

(B) RETAIN THE RISK

Retention of risk involves accepting the loss when it occurs. Risk retention is a viable strategy

for small risks where the cost of insuring against the risk would be greater over time than the

total losses sustained. All risks that are not avoided or transferred are retained by default. This

includes risks that are so large that they either cannot be insured against or the premiums would

be infeasible.

(C) REDUCE THE RISK

Reduction in risk involves methods that reduce the severity of the loss or the likelihood of the

loss from occurring. Outsourcing could be an example of risk reduction. For example, a

company may outsource its manufacturing of hard goods to another company, while handling the

business management itself. This way, the company can concentrate more on business

development without worrying much about the manufacturing process.

(D) TRANSFER THE RISK

Risk transference causes another party to accept the risk, typically by contract or hedging.

Insurance is one type of risk transfer which uses contracts. Liability among construction or other

contractors is very often transferred this way. Such transference of risk may include certain cost

like insurance premium.

MEASURES TO REDUCE THE RISK

Risk management in a Broking Industry is a new concept in India, since it poses maximum risk

in the financial market, managing it was felt most essential by the regulatory bodies and

exchanges. Therefore NSE introduced for the first time in India, risk containment measures that

were common internationally but were absent from the Indian Securities Market. NSCCL has put

in place a comprehensive risk management system, which is constantly upgraded to preempt

market failures. These measures were taken to reduce the brokers’ risks.

Whereas SEBI has given some guidelines under Investors Protection to protect investors risks.

NSE has given the following risk management measures

Margins

NSE has specified Different margins for different instruments like stocks futures and options etc.

Margins depend upon the volatility and market conditions, it vary from stock to stock and

instrument to instrument Categorization of stocks for imposition of margins

Margins

There is a lot of uncertainty in the movement of share prices. This uncertainty leading to risk is

sought to be addressed by margining systems by stock markets. Stock exchange in turn collects

similar amount from the broker upon execution of the order. This initial token payment is called

margin.

For every buyer there is a seller and if the buyer does not bring the money, seller may not get the

money. Margin is levied on the seller also to ensure that he gives the shares sold to the broker

who in turn gives it to the stock exchange.

Daily margins payable by members consists of the following:

1. Value at Risk Margins

2. Mark to Market Margins

Daily margin, comprising of the sum of VAR margin and mark to market margin is payable.

Value at Risk Margin

VAR margin is applicable for all securities in rolling settlement. All securities are classified into

three groups for the purpose of VAR margin. The VAR based margin would be rounded off to

the next higher integer (For E.g. If the VAR based Margin rate is 10. 0 1, it would be rounded off

to 11. 00) and capped at 100%.

The VAR margin rate computed as mentioned above will be charged on the net outstanding

position (buy value-sell value) of the respective clients on the respective securities across all

open settlements. The net positions at a client level for a member are arrived at and thereafter, it

is grossed across all the clients for a member to compute gross exposure for margin calculation.

For example, in case of a member, if client A has a buy position of 1000 in a security and client

B has a sell position of 1000 in the same security, the net position of the member in the security

would be taken as 2000. The buy position of client A and sell position of client B in the same

security would not be netted. It would be summed up to arrive at the member's exposure for the

purpose of margin calculation. VAR margin rate & Security category

Mark-to-Market Margin

Mark to market margin is computed on the basis of mark to market loss of a member. Mark to

market loss is the notional loss which the member would incur in case the cumulative net

outstanding position of the member in all securities, at the end of the relevant day were closed

out at the closing price of the securities as announced at the end of the day by the NSE. Mark to

market margin is calculated by marking each transaction in scrip to the closing price of the scrip

at the end of trading. In case the security has not been traded on a particular day, the latest

available closing price at the NSE is considered as the closing price.

In the event of the net outstanding position of a member in any security being nil, the difference

between the buy and sell values would be considered as notional loss for the purpose of

calculating the mark to market margin payable.

Extreme Loss Margin

The extreme loss margin aims at covering the losses that could occur outside the coverage of

VAR margins. This margin rate is fixed at the beginning of every month, by taking the price data

on a rolling basis for the past six months.