The Hindu Business Line : Regulator’s neutrality a must to ensure level field

The growing monopolistic trend in the stock exchanges is not in the interest of investors. It is time alternative trading platforms are created, on the lines of electronic communication networks and other initiatives in some developed markets, says M. R. MAYYA.

The SEBI Chairman, Mr C. B. Bhave, deserves to be congratulated for his recent statement that SEBI “has no intention of forcing any merger or consolidation between the Bombay Stock Exchange and the National Stock Exchange” adding that “it wants to promote competition among bourses in the country”.

Unfortunately, the stand taken in the initial stages of SEBI regulation was to encourage the NSE and curb the BSE’s growth.

The NSE was set up in November 1992 with ample funding from financial institutions and commercial banks, as a state-of-the-art stock exchange — a rare experiment, as stock exchanges the world over are set up by private enterprise and not by government-sponsored institutions.

Against this , the BSE had to face hurdles placed in the way of its efforts to raise resources by admission of 96 new members, each with an entrance fee of Rs 55 lakh, with the regulator raising objections to the admission procedure, seemingly with a view to crippling the Exchange’s operations.

No neutrality

As a result, the BSE’s computerisation programme was delayed as the Exchange did not otherwise have the resources to meet the cost of computerisation. The decision to admit new members, which was taken in 1991-92, could be completed only in 1993-94. This, in turn, delayed commencement of online trading through the BSE On-Line Trading System, which commenced only in March 1995.

The NSE had, however, started online trading in November 1994. Subsequently, knowing full well that the strength of the BSE lay in badla trading — trading with carry-over facility from one settlement to another — the regulator banned badla trading in January 1994.

Another instance of the lack of neutrality by SEBI was that when the NSE was allowed to conduct online trading from all over the country right from the beginning, in November 1994, the BSE was granted permission in this regard only in March 1996.

Even the advantage the BSE enjoyed by the introduction of modified carry-forward system operative from January 1995 was neutralised by the commencement of Automated Lending and Borrowing Mechanism (ALBM) by the NSE in February 1999, which was akin to badla, the difference between the two being the same as between Tweedledum and Tweedledee.

In fact, badla had an edge over ALBM as the checks and balances in the badla system by way of margins, limits on holdings, etc., did not exist in ALBM.

As a result, even in 1995-96, the NSE recorded a turnover of Rs 67,287 crore, while the BSE’s turnover declined from Rs 67,749 crore the previous year to Rs 50,064 crore.

Thereafter, the BSE’s share has been progressively shrinking while that of the NSE has been rising. In 2007-08, while the BSE clocked a turnover of Rs 15.79 lakhs crore, the NSE’s turnover zoomed to Rs 35.51 lakh crore, with practically no trading at any other stock exchange in the country. The BSE’s share is a meagre 30 per cent or so, and the NSE’s is 70 per cent.

Derivatives

The NSE did not have the prime mover advantage in derivatives that it had in the cash segment. Trading in derivatives started simultaneously both at the NSE and the BSE in June 2000. In fact, in the ten months from June 200 to March 2001, the volume of turnover in the BSE was higher, at Rs 2,365 crore against Rs 1,673 crore at the NSE.

The Ketan Parekh scam exposed in March 1991 virtually dealt a death blow to the derivatives segment at the BSE. As a result, turnover at the Exchange hardly registered a worthwhile rise.

The turnover at the NSE zoomed year after year, to register a staggering figure of Rs 130.90 lakh crore in 2007-008. At present, the turnover at the BSE has virtually zeroed down.

The blame for the debacle in the derivatives segment has to be borne by the members of the BSE who, by switching over their operations to the NSE, subjugated the interest of the exchange to their own personal interest, despite the fact that the benevolence of the regulator was with the BSE during the last three years.

SEBI’s recent decision permitting cross-margining between the cash and derivatives segments will give a further advantage to the NSE over the BSE, as there is no trading in derivatives in the latter, at present.

As a result of all these factors, the BSE’s share in aggregate trading is hardly 10 per cent as against 90 per cent by the NSE, which is progressively occupying a monopolistic position in the market. It is now an uphill task for the BSE to notch up any worthwhile turnover in derivatives.

How sad it is that the Sensex, being the bellwether index of the Indian stock market, tracked the world over, is drawing a blank while trading in derivatives.

As against the present near-monopolistic position among the stock exchanges, there is keen competition today in the depository business between National Securities Depository Ltd. and Central Depository Services (India) Ltd.

As a result, there has not only been a significant reduction in the charges investors pay (in fact, they no longer pay any custody charges, which used to be levied till about five years ago) but also in terms of service. The Indian depository system has indeed become a model for the global markets.

Monopolistic trend

The monopolistic trend in the stock exchanges, gaining strength day by day, is not in the interest of investors. It is, therefore, time we thought of creating alternative trading platforms on the lines of developments in some of the developed markets.

Electronic communication networks (ECNs) which match orders of clients and send the residual trades to the stock exchanges have sprung up in these markets.

These ECNs got a fillip last year in the United States with the introduction of REGNMS, a statutory rule which mandates that trades be sent to the venue offering the “best execution price”.

The European Union’s new MIFID directive does much the same. In the US, the share of the old exchanges in the turnover has dwindled from 86 per cent in April 2007 to 73 per cent in April 2008.

Irrespective of whether ECNs are set up or not, ways and means to curb the monopolistic trend in the stock exchanges need to be evolved.

The BSE can do it provided its members make the initial sacrifice of executing trades in the derivatives segment, even if it means a little loss to them.

Once this is done, automatically liquidity will be generated which can lead to higher volumes getting progressively executed. Will they do it? Time alone will decide.

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

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