Reward points: FIIs pay brokers ‘soft dollar’ for fringe services

Najaf Ishrati

April 24, 2006,
ET Front Page, Mumbai

THE concept of ‘soft dollar’ payments has been around in the US securities market for quite sometime now, and has recently made its way into India.
The term ‘soft dollar’, in the Indian context, is described as payments made by foreign institutional investors (FIIs) to Indian brokers, which are outside the ambit of normal brokerage charges. According to some Indian brokers, whom ET spoke to, this ‘soft dollar’ share can, at times, be as large as 5-10% of their total income.
These payments are for various services rendered by Indian brokers to their FII clients. These payments are legitimate, but are of a discretionary nature. They are over and above normal commission charges.
There is a rise in number of Indian brokerages which ramped up their research capabilities, and even those who were earlier providing a pure transacting platform now have begun to generate research based ‘buy and sell’ reports. Basically, it is for these reports, which FIIs receive, that brokers are paid ‘soft dollar’.
Further, these brokers service their FII clients by setting up meetings with the management of any company that the FII client wants to invest in. Also, some Indian brokers send their analysts abroad to their clients’ offices in Singapore, New York or London ( in most cases) for discussions and advice.
Finally, hotel and travel arrangements are made by brokerages for their clients. Obviously, all this comes at a cost, but there is no official ‘fee’ that is charged for these services, including the reports. FIIs, which use these services, have their own limitations in terms of the business that they can provide.

SEC concerned over ‘soft dollar’ transactions


INDIAN brokers are receiving ‘soft dollar’ payments for the services rendered to their FII clients.
Internal compliance regulations as regards the balance sheet size of their broker-dealers limit the number of brokers that they can make transaction through. Secondly, major funds invest across the globe and prefer to maintain an on going relationships with their broker-dealers across continents. Thirdly, although there is a restriction on domestic mutual funds that they should not give more than 5% of their business to a single brokerage house, there is no such requirement on FIIs.
The net result is that nearly 80% of the business by foreign funds in India would go to Tier I brokerages, (local arms of foreign brokerages like CLSA or Deutsche). Up to 20% of the business would go to Tier II brokerages, which are major domestic firms. In India, they would be the likes of Enam, Motiwal Oswal, ICICI Securities. And around 5% would be invested through small Tier III brokerages. Some of the FIIs, which utilise inputs offered by Tier II and III Indian brokerage houses, do not end up giving them a huge volume of business. It is in these cases that a few FIIs choose to pay ‘soft dollar’ instead.
Sources say that the US SEC is looking to curb soft dollar transactions, as the regulator sees it as a grey area, which may be used to push up prices of equities. The Indian brokerage industry is following developments in this area, but is not unduly worried, as they say that it is the ‘hard dollar’ that they are looking at, and any `soft dollar’ received is considered more as a bonus rather than as revenue.