Detailed Rationale

CRISIL Ratings has reaffirmed its 'CRISIL A2' rating on the short-term bank facility of IKM Investors Private Limited (IKM). The rating continues to reflect comfortable capitalisation and adequate risk management systems and procedures. These rating strengths are partially offset by the average but improving earnings profile, marked by dependence on a single revenue stream and vulnerability to regulatory changes, and volatility inherent in capital-market-related businesses.

 

IKM's capital position has been supported by stable accretions. The company has been reporting profits consistently for more than 10 years which has helped in improvement of its networth. The company also has a strong risk management system which helps in averting losses. It deals mainly in arbitrage operations and hedges significant proportion of its exposures.

 

IKM’s performance continued to improve during fiscal 2023 on the back of strong performance shown by capital markets in India. The company has reported growth in total income of around 9% (Y-o-Y) to Rs 90.9 crore in fiscal 2023 (Rs 84.42 crore in fiscal 2022). The benefits of improved top line were evident in bottom (PAT); IKM’s PAT improved to Rs 18 crore in fiscal 2023 as compared to Rs 17 crore in fiscal 2022 and Rs 12 crore in fiscal 2021.

 

Nevertheless, IKM operates only in a single line of business, which results in concentration of the revenue profile. The company's major revenue source is through arbitrage trading operations. Furthermore, given that arbitrage operations are linked with performance of capital markets, the revenue also fluctuates with market volatility. Apart from volatility, the company also remains exposed to various regulations which directly or indirectly impacts its operations.

Analytical Approach

For arriving at the rating, CRISIL Ratings has considered the standalone business and financial risk profiles of IKM.

Key Rating Drivers & Detailed Description

Strengths:

Comfortable capitalisation

Adjusted networth and gearing stood Rs 152 crore and 0.1 time, respectively, as on March 31, 2023 improved from Rs 141 crore and 0.1 time, respectively, as on March 31, 2022. Networth has grown consistently due to steady internal accrual. In addition, given high levels of hedged arbitrages (around 95% of transactions are hedged), risk of capital erosion is low. In addition, since the management may continue with its policy of high level of hedging of arbitrage transactions, risk of losses and consequent decline in capitalisation remain low.

 

Adequate risk management systems and procedures

The company generally limits trades to liquid scrips so that positions can be squared off quickly and hedges its arbitrage positions immediately. Size of trades is also small so that they are easily executed and reversed. Arbitrage strategies adopted by IKM include cash–future, future–future, and index–future. Trading strategies to be adopted by dealers are decided beforehand, and limits for fund allocation are set for each dealer. The risk department monitors trades on a real-time basis, to ensure dealers adhere to strategies and fund limits. Reports on trading positions, and breaches, if any, are sent to the senior management at half-hour intervals and at the end of the day. The company is developing expertise in high frequency trading by using statistical arbitrage trading strategies, usage of which requires a thorough understanding of underlying models and assumptions. Despite adequate risk management systems and procedures for current line of operations, ability to appreciate and efficiently manage risks arising out of such sophisticated systems, will be a key rating monitorable.

 

Weakness:

Average though improving earnings profile

Earning profile is modest with return on equity (RoE) and volatility in profit. The RoE was 12.4% as on March 31, 2022; it improved from 10% the previous year. In the fiscal 2023, the RoE is around 11.7%. Increased trading volume, aided by algorithmic programmes to skim low-margin arbitrage opportunities and constant cost reduction, is the key to maintaining profitability, given the intense competition and continued low retail participation in equity markets.  In addition, as IKM is only engaged in the arbitrage trading business, revenue profile remains dependent on a single stream. The management has no major plans to get in other business avenues such as broking or funding to clients. Therefore, the earnings profile will continue to remain dependent on performance of arbitrage book.

 

Susceptibility to the risk of regulatory changes

Over the last couple of years, the broking industry has witnessed continuous regulatory revisions. With the objective of further enhancing the transparency levels and limiting the misuse of funds, SEBI has introduced a few regulations in the last one year. Some of these regulations include upfront margin collection for intraday positions and limiting the usage of power of attorney. The industry is undergoing changes pertaining to margin collection and pledging practices effective September 1, 2020. The newer margin collection practices will change the vintage business model of various small to mid-sized broking companies that relied on relationships by offering differential leverage and margin payment avenues to clients. This is likely to lead to decline in the overall competitiveness towards larger digital and bank-based brokers.

 

The regulations of upfront margin collections for intraday trading have decreased the leverage levels in the industry to 4-5 times from the current 10-15 times prevalent across the industry. While these regulations have not directly affected IKM’s performance so far, CRISIL Ratings will continue to monitor the same on an ongoing basis. Furthermore, as per new regulations, the shares owned by investors can be lien marked with the respective broker instead of having to follow the current practice of transferring it to the broker’s pool account. CRISIL Ratings understands that most top brokers have already streamlined their systems in accordance with the revised regulations. However, IKM is not in client broking business, this regulation is also not expected to have any impact on the operations on an on-going basis. CRISIL Ratings believes that these regulations will benefit the industry with increased transparency and the de-risk broking platform for retail customers.

 

Exposure to volatility inherent in capital market-related businesses

Operations are concentrated primarily in the equity market space through arbitrage trading. Arbitrage volume and earnings are heavily dependent on level of trading activity in capital markets, which in turn, are driven by economic, political, and social factors guiding investor sentiments. Turnover and volume in the equity broking business move in tandem with market sentiment. Global factors also influence fortunes of the domestic market. CRISIL Ratings, therefore, will continue to monitor the performance of IKM in accordance to volatility in capital markets.

Liquidity: Adequate

IKM does not have any term-based borrowings and all borrowings are largely against FDs for availing margin limits from the Exchange. The company usually maintains liquid funds of ~Rs 180-200 crore at the exchange level in the form of cash, FDs, and BGs for taking exposure. As on June 30, 2023, company had cash and cash equivalents stood at Rs 135 crore.

Rating Sensitivity Factors

Upward Factors

• Return on equity above 20% on a consistent basis
• Cost-to-income ratio improving to below 60% on a steady-state basis

 

Downward Factors

• Deterioration on capital position with networth reducing to below Rs 100 crore
• Deterioration in earning profile with return on networth reducing to below 5%

About the Company

IKM, based in New Delhi, incorporated in 1995, is a part of the IKM group, which was set up in 1961 by the late Mr Inder Krishen Malik; the company's current promoter is Mr. Rahul Malik. It undertakes arbitrage trading in equity markets. 

Key Financial Indicators

Particulars March 31	Unit	2023*	2022	2021
Total Assets	Rs crore	192	178	158
Total Income	Rs crore	91	84	73
Profit after tax	Rs crore	18	17.3	12.4
Gearing	Times	0.1	0.1	0.0
Return on equity	%	11.7	12.4	10.0

*Provisional

Any other information

CRISIL Ratings has been monitoring the SEBI’s investigation that was underway w.r.t co-location facility used by IKM during period 2012-2014. During fiscal 2020, SEBI had conducted forensic audit to investigate whether IKM got any favored access to market data through the co-location facility of NSE in 2012-14. On June 15, 2021, SEBI passed 2 orders wherein total penalty of Rs 6 lakhs was imposed on IKM. The first SEBI order imposed a monetary penalty of Rs 1 lakh each on two directors (Mr Rahul Malik and Mr Pramod Jain), and Rs 1 lakh on Chief Operating Officer (COO-Mr Rochak Midha) of IKM on account of non -cooperation during the audit. Nevertheless, the directors decided to appeal against this order and approached SAT (Securities Appellate Tribunal). CRISIL Ratings understand that on November 25, 2021, SAT hearing was scheduled, and judgement was passed in favour of IKM’s directors/COO. Therefore, the penalty of Rs 3 lakhs imposed on directors/COO has been quashed. CRISIL Ratings will, nevertheless, continue to monitor any developments in this regard. 

 

Furthermore, SEBI also passed another order on June 15, 2021 with respect to issues pertaining to connections to the secondary server in 2012-14. For this, SEBI has imposed penalty of Rs 3 lakh on IKM (on the company). As a further update, the management has confirmed that this penalty has been paid on December 27, 2021. While this matter is considered to be closed from company’s perspective, CRISIL Ratings will continue to monitor further developments (if any) in this regard.