Dabba trading ducks SEBI, thrives

At a time when stockbrokers are grappling with lower volumes and waning interest of retail investors, business in dabba trading has doubled despite there being a ban on such transactions in the country.

Also read: Explained: How dabba transactions bypass SEBI rules

Experts say changes made in the rules for margins by the Securities and Exchange Board of India (SEBI) and which came into effect from September 1, 2011, have led to a rise in dabba trading.

Dabba trading, a method by which shares are traded after bypassing the stock exchanges, is prohibited as it amounts to running a parallel market, free of all rules and regulations. There are no guarantees of pay-in and pay-out as there are no written contracts and no invoices or bills are issued. The settlement cycles are decided by the dabba operators themselves.

It is a criminal offence, no different from smuggling or black market trade. As all transactions and client details are kept opaque, it is a major contributor to black money in the country.

The growth in volumes of dabba trading can also be attributed to the fact that it does not entail any compliance issues or tax burden, incurs minimum transaction costs, and offers the additional advantage of a non-standardised lot-size.

More importantly, dabba trading can be conducted without fear of attracting capital gains tax. The entire market operates on the basis of cash settlement done at the end of the week. Pay-in by the client in case of loss and pay-out by the broker in case of profit are both done at the end of the week.

“Surat is the hub of dabba trading in Gujarat. Ahmedabad, Rajkot and Bhuj are other large trading centres. Recently, smaller towns like Unjha, Visnagar, Palanpur in North Gujarat and Dhoraji, Upleta and Morbi in Saurashtra are also contributing significantly to the volume of business,” an operator said.

Dabba trading derives inspiration from bucket trading shops in the US from 1870s to 1920s. Here transactions –orders of clients to buy or sell shares — are not routed through the official exchange platform. They are just recorded in the book or register maintained by the dabba operator, and payment is done on a weekly basis.

Sources in the market say that the total volume of trade transacted through dabba trading is as high as the total volume of trade in the derivative segment of the National Stock Exchange (NSE).

“It is difficult to have a clear idea of the total dabba trading volume in the country. However, I can confirm that Gujarat’s volume is an estimated Rs25,000 crore a day,” a Rajkot-based dabba operator said. He added that this had almost doubled since Sebi and the stock exchanges changed the margin rules in September 2011.

The National Stock Exchange (NSE) recently asked stockbrokers to discontinue depositing shares of clients to fulfil margin requirements of the exchange. Also, delayed payment norms were made stricter. The NSE has also started levying penalty on margins shortfall at the rate of 1% per day of the amount of shortfall.

Speculators find dabba trading attractive as most of the trade is done in the futures market. A client can short-sell (selling without holding the delivery) and go long with whatever quantity he deems fit.

“There are no standard contracts, lot-sizes, margin money requirements or transaction tax in dabba trading. Deals are done only on the basis of mutual trust,” said an Ahmedabad-based dabba trader.

While the cost of equities trading, including brokerage, in the US and Europe is around Rs500 on trades worth Rs1 crore, it is as high as Rs1,200 in India. Additionally, a client of the Bombay Stock Exchange (BSE) or the NSE has to shell out taxes, transaction fees, brokerage, and commission. As dabba trading bypasses the exchanges, it is a much cheaper mode of buying or selling shares in India.

To give an example, for an investor desirous of going long or short on Reliance Industries Limited (RIL) in the derivatives segment, the lot-size per contract is 250 shares of the company. To trade, the investor needs to deposit at least 16% of the total value of the shares as margin money. Margin money being mark-to-market means the investor’s requirement of margin money increases or decreases depending on rise and fall of the prices of the share.

“In contrast, in dabba trading a client can buy or sell even 25 shares of Reliance as there are no standard contracts. There is no requirement of margin money. As the entire transaction is executed through a pseudo-channel there is no requirement of compliance, and transaction taxes. And to top it all, there are no taxes on capital gains or loss at the end of the year, as most settlements are done in cash,” said an operator.

Dabba traders have also modernized their operations to counter the threat of SEBI raids and increased policing.

“Large brokers now do not maintain a notebook or register. They do not even record the transactions on a computer. There is software available in the market which does the job for them,” a software vendor said on the condition of anonymity.

This software is installed on the normal terminal provided by the official broker or exchange. For transaction, it continues to use the official software provided by the exchange.

“But when the dabba trader calls, he punches the price and quantity of the stocks to be bought or sold, in the terminal. He executes the trade but without getting it registered on the exchange as they are blocked by this ‘killer’ software. All dabba trades are blocked and grouped into a separate file for the weekly settlement,” a software vendor said.

A mobile application has also been developed for dabba traders. For a three-month subscription of Rs1,800, a trader will be able to track live market rates from anywhere in the country. “This application is mostly used by front operators who don’t have huge clientele or volumes,” the vendor added.