Several UAE brokerage firms – faced with the prospect of low third-quarter earnings – are considering suspending operations for a year with a view to resuming business once the markets revive.

Amanah Financial Service has already applied to the Emirates Securities and Commodities Authority (Esca) for permission to freeze operations for a year. The company also has a licence from the Central Bank to manage investment funds.

Fee-driven revenues are in continual decline and a number of non-banking companies are moving towards consolidation and mergers – while others are preparing for complete closure.

The trend is set to shake up the industry in the country, and some analysts predict that 30 per cent of brokerage firms will disappear by the end of the year.

"Though trade values improved during the second quarter this year compared with the fourth quarter of last year, revenues did not cover the operating costs of majority of the firms," said Humam Al Shamaa, a financial consultant at Al Fajr Securities.

"At the moment, they find themselves in a critical situation and many will start shutting down or, at least, freeze their operations in the hope that the markets will pick up again and they can relaunch their operations later."

Seven non-banking firms have held merger talks that are expected to lead to the creation of a single strong brokerage company. And market sources said several firms were put up for sale during the past six months – but buyers could not be found.

Only 13 out of the 99 brokerage companies registered with the Dubai Financial Market and the 92 registered with the Abu Dhabi Securities Exchange managed to make profits in the first quarter of this year. Most of the firms are registered with both markets.

The number is thought to have increased in the second quarter due to increasing trade volume on the markets, but difficulties remain in the vast majority of brokerages due to the limited room for revenue generation.

Trading values have declined again since the beginning of the third quarter, increasing worries that some firms will not be able to remain in business.

Most of the owners of small brokerage firms are basically active investors in the stock markets who suffered major losses at the beginning of the financial crisis as the markets declined sharply. As a result many are no longer able to support their companies due to the continuing low revenues and high operating costs.

"The hardships faced by the industry have not eased since the beginning of the year because of the low level of trading values along with the deterioration of stock values and, consequently, the holdings of brokerage firms and their clients," said Hosam Al Husseini, Head of Brokerage at Emaar Financial Services.

Esca rules require brokerage firms to charge a fee of 0.015 per cent, one of the lowest rates in the Middle East. The fee percentage in neighbouring Oman is almost double the UAE rate.

Al Shamaa said: "Esca has reduced brokers' fee by 50 per cent compared with the past three years. This had a great impact on the revenues of brokerage firms even before the financial crisis."

"Besides, the increase in the minimum capital requirement to Dh30 million placed a further burden on the companies. This situation led to a sharp drop in the revenue-to-capital ratio and a lot of brokerage firms owners are finding it difficult to remain in business."

However, Al Husseini said the drop in fees had tempted speculators and short-term traders to enter the market.

"The low level of fee is encouraging speculators to move in a thin range of the market. They are buying and cashing out in a range of around three fils and this generates some revenues for brokerage firms," he said.

"The real challenge is diversifying the sources of revenues. We are not allowed to manage investment funds, give advice to our clients or trade on the margin. Fees are the only revenue we have and this is very critical. Esca should allow us to offer other investment tools."

Esca has taken strict measures against some brokerage firms during the past two years after discovering unregulated practices and irregularities that harmed the markets and investors.

"We understand that Esca's measures were intended to protect investors, but they should not harm brokerage firms," added Al Husseini.

"We should be able to generate revenues. Brokerage firms have no other ways to generate revenues. They cannot open investment funds because Esca prevents this and they have to get a licence from the Central Bank that requires a capital of Dh40m. Alternatively, they can get a licence from the Dubai International Financial Centre at the far lower cost of $500,000 (Dh1.83m), but the process takes about one year."

The sharp decline in markets has also affected brokerage firms trading in commodities and currencies.

Worries about renewed layoffs have increased recently because of the problems faced by brokerage firms. There was a wave of redundancies at the start of the year and further job cuts are expected in the next three months because of the anticipated mergers, closures and suspension of operations.

A broker at a non-banking firm, who spoke on condition of anonymity, said: "We have not been paid for three months and August will be the fourth month. Brokers and other staff are facing a critical situation.

"The market is very tight and we do not expect any strong improvement in the next two months. My company is in the process of shutting down. We are service providers and there should be major investors requiring our services. The current speculative and short-term trading in the markets offers limited revenues that cannot cover the operating costs and salaries of staff in brokerage firms."

Another broker at one of the top bank brokerage arms confirmed that there were fears of job cuts as most companies failed to cover their operating costs during the first half of the year.

"We faced severe layoffs at the beginning of the year," he added.

Companies are doing their best to manage their costs through layoffs and salary cuts. However, they can cut salaries only to a level that guarantees their staff a minimum standard of living.

Also there are limits on how many jobs they can cut as Esca requires each company to have a minimum of four brokers, one trading manager, a general manager, an operations manager, a financial manager, a customer services section, researchers, analysts and other support staff.

Al Husseini said: "Even if we cut staff, we need to meet Esca's requirements. Mergers are a good idea as several companies will be able to work with a limited capital requirement and a limited number of staff.

"We will find a lot of brokers, analysts and other staff without jobs in the next few months. This skilled labour force should be allowed to offer financial services and generate revenues."

Big players suffer too as operating costs climb

The top 10 brokerage firms at the DFM dominated trading in July, accounting for 42.78 per cent of the total trade value during the month. And the top 10 firms at the ADX attracted 47.91 per cent of last month's total trade value.

There is a widespread perception that the brokerage arms of banks and major players are better equipped to survive the downturn as they have strong cash positions that will enable them to continue operations.

"Brokerage firms affiliated to banks are in a far better position than others," said Humam Al Shamaa, a financial consultant at Al Fajr Securities. "Banks can offer facilities and loans to clients of their brokerage arms and this has attracted investors to these companies. Independent brokerage firms face a critical situation and shutting down could become inevitable."

However, some large firms and those affiliated to banks are facing problems because their operating costs are higher than those of the smaller independent firms. Besides, large brokerage firms face another burden as they are offering discounts on their fees to attract major investors.

Hosam Al Husseini, Head of Brokerage at Emaar Financial Services, said: "Despite the relative advantages of large firms and the brokerage arms of banks, some have recorded losses and banks will not be able to continue financing them.

"Our monthly operating cost is about Dh1.2 million. This means that we should achieve a monthly turnover of about Dh750m, or Dh30m every trading day, to cover our operating costs. This is very difficult due to the sharp drop in trade values. Small and large brokerages are facing the same hardships because the minimum monthly operating cost of a small firm is about Dh350,000."

Al Husseini said Emaar Financial Services made profits of about Dh500,000 during the first quarter and about Dh2.5m in the second quarter. "However these profits are very modest compared with the high risks in the business in general. If one client defaulted or a broker made just one trading order error – a common risk in the brokerage industry - it could lead to a loss of Dh 2m. This would wipe out our profits for a whole quarter."