Capital market regulator SEBI will review the practice of exchanges offering pass-backs or rebates to brokers for transactions in the futures and options (F&O) segment, a source familiar with the development told Moneycontrol.

Based on the final call Sebi may take on the matter, this will have significant implications for F&O volumes that have gone through the roof post COVID on frenzied retail participation.

Simultaneously, this could also affect the profit margins of discount brokers like Zerodha, Groww, Upstox and AngelOne who are able to offer ultra low brokerage charge in part because of pass-backs from exchanges.

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“We are concerned about this and are reviewing this,” the source said on the matter of exchanges offering rebates, but declined to give any further information.

Both the BSE and NSE charge brokers a transaction fee based on turnover. The brokers collect this fee from their clients and forward it to the exchanges.

At the broker level, higher the turnover value, lower the transaction charges they have to pay to the bourses. Usually what most brokers do is to charge clients the highest slab of transaction fee. But when their (brokers) aggregate turnover exceeds a certain threshold, say Rs 2,000 crore, the transaction charge they have to pay to exchanges is much lower. This is a way of incentivising brokers to generate higher turnover, and the incentives are the highest in the options segment.

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Brokers retain the excess they have collected from their clients, and since the top brokers easily gross a few thousand crores of turnover every month, this adds up to a sizeable sum over the course of the year.

A questionnaire sent to SEBI on the matter did not get a response.

The regulator’s rethink comes in the wake of concerns over surging derivatives volume, especially as Sebi study shows that 89 percent of traders end up losing money in stock markets. Sebi has maintained thus far that it is doing all it can to eliminate systemic risk by continuous tightening of margin norms. However, the low probability of making profits and stringent margin requirements have so far failed to dampen the enthusiasm of retail participants for F&O trades.

Much of the activity is in the options trading segment, with retail investors now accounting for around 35 percent the turnover in index options on the NSE as on August 31.

While the NSE has been offering rebates to brokers for a while now, the BSE’s structure for transaction charges announced a couple of days back also has an in-built provision for offering rebates to its trading members.

Exchanges offering incentives to trading members for diverting turnover to their platform is an accepted practice globally. In the US, brokers like Robinhood get rebates from exchanges as well as from market makers, to whom they route their clients’ orders At the same time, the regulator cannot overlook the fact that equity derivatives turnover in India is abnormally higher than cash market volumes, when compared to other global markets.

SEBI will need to balance both aspects when it comes out with a final policy on the practice of rebates by stock exchanges.

“In most markets, derivatives volumes now account for 5-15x their cash market volumes. In India today however, derivative volumes are more than 400x higher than that of underlying cash market today, having grown from 3x in 2010,” Axis MF Chief Investment Officer Ashish Gupta wrote in a note titled Gamification of Indian Equities.

To know how the rebate is calculated and how much brokers may have earned through this system, click here: