The Hindu Business Line : NSE turns 10: A defining decade for the market

THESE are not exciting times for investors. Equity prices are in rough terrain; the outlook for interest rates and bonds is uncertain in anticipation of rate hikes in the advanced economies; and the equity market may be stuck in a narrow band, characterised by a lack of direction, at least till the Budget is presented on July 8.

Opportunities to make money are limited for traders and investors. A steady decline in equity prices over the past couple of months, too, has made investors listless, especially after the heady bull run of 2003. But moving away briefly from the market action, there is a bright spot to be seen in an organisation that has made a difference to investors in India.

Dr R. H .Patil, former Managing Director, NSE

The National Stock Exchange (NSE), which completes 10 years on June 30, has indeed altered the stock market landscape.

It has tilted the market system in favour of investors, away from the significant bias in favour of intermediaries, big and small, for long.

The low-profile approach adopted by the Managing Director and CEO, Mr Ravi Narain, since he took over the reins three years ago pretty much defines the character of the exchange itself.

Mr Ravi Narain, the present Managing Director, NSE

Investors across the country, however, have reason to look at the NSE's ten-year record with cheer, as they have been the beneficiaries of the changes initiated and driven by the NSE.

Within five years of coming into existence, the NSE emerged the market of choice, having captured an overwhelming share of trading volumes.

This was a far cry from its early months, when it counted the purchase and sale side of each transaction separately to magnify turnover levels.

Beyond the defined role

The NSE has grown beyond the modest role envisaged by the M. J. Pherwani Committee, which mooted the idea of such an exchange in 1992.

The thrust of the panel's recommendation was that the Bombay Stock Exchange should become a National Stock Market System; the NSE was intended to provide competition to the proposed nation-wide market.

The BSE was, however, slow to recognise the ground reality and adapt to change; it also did not recognise in time the potential of a National Stock Market System.

The then-fledgling NSE embraced the technology to grow at a pace that has left the rest gasping for market share and survival.

Of the 25 stock exchanges in the country, only the BSE has managed to retain a respectable share of the equity market.

In debt, derivatives and dematerialisaton, the NSE has no competition; this may not be such a positive factor from a long-term perspective, though.

The NSE's growth was also helped by the regulatory framework, which was, in turn, driven by the changes wrought by the bourse.

Even as it gained market-share, the NSE emerged as a catalyst of change. It has played the lead role in ensuring that India's market architecture and systems have become global benchmarks.

Without the standard-setting role of the NSE, the Securities and Exchange Board of India (SEBI) — the other key driver of change in the stock market architecture — would have been hard-pressed to usher in the systemic changes that have altered and improved the trading and settlement systems.

An unfashionable beginning

For a mass of investors across the country, the NSE is now the focal point for trading in stocks, and futures and options.

In June 1994, the NSE started off by trading in debt instruments through the wholesale debt market segment, which attracted only a small number of investors. The capital market segment began trading in November.

The wholesale debt market even today has just 75 members; the average daily trading values have, however, risen manifold over the years; and the turnover on many a trading day surpasses that on the capital market and the futures and options market, either individually and/or collectively.

Even on a dull day, the three segments collectively notch up a turnover of about Rs 15,000 crore.

Setting the standards

Catalogued below are ten of the more significant progressive moves made by the NSE and the consequent changes:

Effective use of information technology and advances in telecommuni- cations has led to an electronic trading and settlement system that now covers every aspect of a stock-market transaction. The time taken to complete transactions has shrunk dramatically in favour of investors.

An electronic trading system has given the NSE a nationwide footprint. With the exception of Mumbai, in every other centre the NSE now clocks a higher turnover than the regional stock exchanges.

The geographic spread has contributed to higher trading volumes, which, in turn, have aided better price discovery.

The NSE's clearing corporation has made a marked difference to the settlement process by providing a guarantee for completion of every trade.

Even on days when the market has gone into a skid — as it did a month-and-half ago or when the tech-bull market came to a grinding halt in 2000 with the Ketan Parekh crisis — transactions were settled without a hitch. There was no closure of the exchange to bail out brokers — a common occurrence even on the BSE in the 1990s.

Institutional ownership has enabled the NSE to adopt a business model that accords primacy to the interests of investors, with brokers just being service providers; the latter do not own and control the exchange — a position they have even today on the other exchanges, and one they have often abused over the decades.

As a professionally managed exchange, the NSE has delivered value to investors and intermediaries. The presence of professionals at the top has played a vital role in this process.

Costs have shrunk for retail as well as institutional investors even as transparency has improved. Today if you buy or sell a stock, you know that the price that is reported to you is the one at which the transaction was executed.

In the pre-NSE days, brokers inflated or depressed transaction prices to suit their interests. It was common for intermediaries to pocket deep-in-the-money transactions; investors were told that the purchase or sale order could not be executed. Investors face no such risks now.

The removal of paper from a market that was overwhelmed by it has been the most significant of NSE's several achievements. Its sister organisation, the National Securities Depository Ltd (NSDL), aided by unstinted regulatory support from SEBI, has been at the forefront of the dematerialisation that has facilitated paperless trading.

The NSE pushed for derivatives for several years before SEBI gave its consentin 2000; it also went on to capture this market in its entirety as the BSE's efforts proved futile.

The introduction of derivatives meant an end to the opaque badla market that operated within the BSE system for decades.

The NSE, too, ran a badla-like market, called the Automated Lending and Borrowing Mechanism, before SEBI put an end to it three-and-a-half years ago.

The checks and balances in the NSE trading system — risk management systems and margin structures — are objective and clearly defined.

The ad hoc approach adopted by the broker-dominated governing boards of other exchanges, committed to protecting the interests of intermediaries, is a thing of the past.

When operations started in the wholesale debt market segment, the secondary market for debt was dominated by transactions put through over phone by well-connected brokers on behalf of banks and other institutional investors. It was a market lacking in transparency, and which offered brokerage and commissions that enriched intermediaries.

Over a ten-year period, a high proportion of trades in government securities and corporate bonds and debentures has shifted from the opaque phone market to the NSE.

The shift to rolling settlement, a tighter settlement cycle, which may move to a T+1 (a day after the trading day) basis over the next year, the introduction and imminent expansion of straight-through processing and the gradual expansion of online trading owe as much to the changes driven by the NSE as to SEBI's regulatory initiatives.

The challenge for the NSE now is to work in tandem with SEBI to clamp down on price manipulation and rampant trading based on inside information, to ensure better compliance by the corporate sector within the letter and spirit of the listing agreement and to enhance the quality of disclosures.

Progress in these areas would be the appropriate follow-up to the systemic improvement and would tilt the market further in favour of investors.

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