Hey, No comments about Zerodha (I'm not aware if and how they do it) but in general, many brokerages do prop-trading. The reason we have stayed away from going down the same path is that we believe that there needs to be a clear distinction between these two activities. Since stockbrokers are also custodians of clients' funds & securities, mixing up the fiduciary responsibilities with prop trading can be disastrous if the management breaks the rules to misuse clients' assets for their benefit.
- While there is nothing wrong with proprietary trading, doing it within the broking entity gives rise to a conflict of interest because the broker has access to all the trading information of clients. There is no Chinese wall, so to speak. Front-running, copy-trading, stop-loss hunting etc., Need I say more?
- Also, since brokerages have access to your idle funds & securities, they can use it to trade on their own books by infusing clients' funds for their trades or by pledging client holdings for collateral margins or even raising loans. This may be the main reason why SEBI has implemented the new Pledge/Re-pledge mechanism via OTPs to avoid unauthorized transactions. It's certainly a step in the right direction.
- The exchange settlement system works like a chain link. Client level MTM is not tracked by the exchanges on a daily basis. A broker (TM) has to pay consolidated MTM obligations from all trades to the Clearing Member (CM) who then makes the payment the Clearing Corporation (CC). They don't really track who is doing those trades at the brokerage.
Long story short, we wanted to avoid conflict of interest with our clients as much as possible. Hence, we didn't apply for a proprietary trading license when getting broking memberships. It has enabled us to be more transparent with clients and focus on our core activities. From day 1 of our business, I've been that its one of our main differentiating factors but most traders didn't take notice until IL&FS went bust and the Karvy scandal broke out. I've written about it here114. Moreover, trading is a separate business and has its own set of requirements. We don't want to lose the plot by mixing these things up. Now, this does not imply that all brokerages that do prop-trading are breaking the rules, but I'm just highlighting some possibilities.
