The Hindu Business Line : Creating an effective trading platform

Both the Inter-connected Stock Exchange and the OTCEI with their vast network can merge into a single platform for trading in the securities of SMEs as also in the tradable securities of RSEs and the BSE.

M. R. Mayya

It is heartening to note that the Securities and Exchange Board of India (SEBI) has invited for expressions of interest for the creation of a separate platform for trading in the securities of small and medium enterprises (SMEs). This should have been set up much earlier, but better late than never.

Most of the advanced markets of the world set up trading platform for SMEs in the early 1980s. In fact, Nasdaq, which has emerged as the second biggest stock market of the US, was established in 1971. At present, more than 50 alternate markets, stocks exchanges, boards of trade and lower tier exchanges for SMEs are thriving across the world.

For India, it is all the more necessary to set up such a trading platform, as bank finance is not easily available for SMEs, despite exhortations by the Government and the Reserve Bank of India to augment the credit flow to this sector.

Development of SMEs is necessary, particularly because liberalisation and globalisation have, within a short period of a decade-and-a-half, resulted in tremendous concentration of wealth in the hands of MNCs, both foreign and home-grown.

Indonext, a pet project of the Finance Minister, Mr P. Chidambaram, which was inaugurated by him in January 2005, has not lived up to expectations. Of the 535 securities listed on Indonext, as many as 505 are listed on the Bombay Stock Exchange (BSE) as well; only the remaining 25 are listed exclusively on Regional Stock Exchanges (RSEs). And the turnover on Indonext, at about Rs 230 crore, too has not been significant.

Limited trading

Despite the tremendous progress Indian stock exchanges have made in the last 12 years, a major problem which still needs to be tackled is the illiquidity of several listed scrips in which there is no trading happening at all. There are about 4,000 exclusively listed companies on the RSEs, in which there is no trading. Of these exclusively listed scrips on the RSEs, at least scrips of 500 companies, which are fully compliant with all the regulatory requirements, are tradable.

Even on the BSE, of the 7,753 listed scrips only about 2,700 are traded. Investors in all these scrips have no exit route, because of which they cannot even book losses; under the Income-Tax Act, losses can be booked only if there is a transfer.

The OTC Exchange of India (OTCEI), which was set up in 1992 exclusively for small-cap companies, could not succeed because of the introduction of rolling settlements, screen-based trading, and so on without adequate technology support.

Readymade platform

There is no need whatsoever for setting up a separate trading platform. There is a already a ready platform created by the 13 RSEs, providing for trading in all the securities listed on the RSEs as also in the securities listed on the NSE and the BSE as permitted.

This platform has not be successful thus far mainly because of the lack of exclusivity of trading and as the major RSE operators were unwilling to shift even a part of their trading volumes to the ISE (Inter-connected Stock Exchange) trading platform.

Moreover, although the ISE was declared as a regional stock exchange for the State of Maharashtra by SEBI, it could not succeed in getting listing of any worthwhile companies due to the lack of regulatory support.

As a result, the ISE has been reduced to the position of an RSE, trading through its subsidiary on the NSE and the BSE with a network of 801 traders and dealers spread across 146 centres in 18 States and two Union Territories.

Both the ISE and the OTCEI with their vast network can merge into a single platform for trading in the securities of SMEs as also in the tradable securities of RSEs and the BSE. Besides, about 350 active members of RSEs can also operate on this platform. Hundreds of crores rupees spent by the ISE, OTCEI and their members, which otherwise would get wasted, can be utilised fruitfully.

Market makers

Mere creation of a trading platform will not solve the problem. Incentives must be offered to traders on this platform. At least two market makers should be appointed for each scrip and the responsibility for the appointment should rest with the issuers.

The issuers should supply each of the market makers with at least 2 per cent of the issued capital at the same price at which it is offered to the public. Market makers must also be given adequate credit facilities from banks, preferably at a concessional rate. Fiscal concessions must also be offered to market makers in respect of the profits arising out of market making functions.

Above all, the spreads between bids and offers that would be given by the market makers should not be subject to any limits. Competition among market makers will ensure that the spreads narrow down to reasonable levels.

Appointment of market makers has hitherto failed, basically because of the regulatory restrictions on the spreads between bids and offers.

But market making alone will not generate liquidity in all the tradable securities. This needs to be supplemented by the call auction system. Under this system, all investors and brokers have the facility to upload their buy and sell orders.

At the closing time of a trading session, bids and offers which match will be executed. A few of the developed markets of the world have already introduced the call auction system in respect of thinly traded securities.

(The author is a former Executive Director of the Bombay Stock Exchange.)