At a sprightly 20 years, the National Stock Exchange (NSE) looms large over the equity market landscape in India; its competitors, the BSE and the MCX-SX, are dwarfs in comparison.

It is the brilliance shown by the founders of the NSE, led by R.H. Patil, in visualising a technology-driven pan-India platform in the early nineties that transformed the equity markets in India and helped spread the equity investment culture to every nook and corner of the country.

This meticulous planning and implementation has resulted in the NSE garnering over 80 per cent share in the cash and derivative segments of the equity market and 75 per cent share in currency derivatives.

But the exchange is currently grappling with declining retail investor interest even as institutional investors are dominating trading. The challenge in the next decade is to win back retail investor confidence and create a level playing field for all investors.

The initial years

While the growth of the NSE in the initial years is legendary, this section is for the younger breed, not fully aware of the history.

The timing of NSE’s launch coincided with the increased usage of Internet in India. NSE could, therefore, rope in the growing number of tech-savvy brokers and sub-brokers who easily migrated to trading on the more investor-friendly platform. The low opening price of membership card on the NSE, compared with the exorbitantly-priced and scarce BSE membership, too made many wannabe brokers take to the new exchange.

And how did the BSE lose out? The BSE operated a ring-based open outcry system of trading out of Jeejeebhoy Towers in Dalal Street when NSE began its operations.

It was also stipulated to cater to only investors in and around Mumbai (then Bombay). Though the BSE shifted to online trading in May 1995, the government did not give it permission to expand nation-wide until 1997.

This two-year delay was the destiny-changer for the BSE, as the NSE forged ahead during this period to become the largest stock exchange in the country.

The gap between the NSE and the BSE widened over the years. Derivatives trading was launched by both the exchanges simultaneously in 2000 but NSE cornered a lion’s share again because traders preferred this exchange as it offered greater liquidity, lower spreads and better price discovery.

Lower transaction charges on the NSE during the initial period also helped.

The third stock exchange in India offering equity trading, MCX-SX, has been unable to make any dent in the NSE’s market share since it began equity market operations in February 2013.

With its promoter in deep trouble over the other exchange he operated, the National Spot Exchange of India Ltd, this challenger is not likely to trouble NSE’s near-monopolistic position anytime soon.

The role of NSE in propagating the equity culture in the country is undisputable. During the first twenty years of its existence, the exchange built state-of-the-art infrastructure, a near-glitch free trading platform, robust surveillance system and a clearing mechanism that has hardly experienced a hiccup in the last two decades.

But there are many issues that the exchange needs to address in the years ahead.

retail participation

It is no secret that retail participation in the equity market has reduced significantly in recent years. One indicator of the retail investor apathy is the falling cash volumes in the exchange.

From a daily average turnover of almost Rs 17,000 crore in 2009-10, there is a 35 per cent drop with the exchange clocking around Rs 10,000 crore of turnover currently.

The weak market conditions, with most mid- and small-cap stocks losing more than half their value since the 2010 peak, could partly account for this investor disinterest.

But there is no turning away from the fact that there are issues that the exchange needs to address if it wishes to retain the present set of investors and attract new ones.

The HFT issue

Even as cash volumes are on the wane, average daily volumes in the derivative segment have more than doubled since 2009-10.

Trading activity is largely driven by large institutional players trading through co-location facilities (trading through servers placed in the exchange premises). These facilities are used to put in computer driven (algorithm based) orders, one set of which is high frequency trades (HFT).

HFTs flood the exchange server with high-speed trades that crowd out other trades from smaller investors, thus giving larger players an unfair advantage.

Dominance of these HFTs has led to concentration of trading in a few stocks. The top 100 stocks account for more than 80 per cent of total cash turnover.

The magnitude of this issue can be seen from the data from the World Federation of Exchanges that shows NSE has the maximum number of trades from its electronic order book (cash segment) among global exchanges.

This is even higher than the cash trades on the exchange behemoth NYSE Euronext.

Computer-driven trades in the cash and derivatives segment on the NSE currently account for around 40 per cent.

It, however, needs to be stated that most other global exchanges are also confronted with the problem of HFTs pushing out other traders and investors.

There are no easy solutions to this since clamping down on these trades can affect liquidity and price discovery. Restricting HFTs to derivatives alone is one solution. Higher cash penalties on terminals that have low order-to-trade ratio could be another option.

Strict surveillance

The exchange also needs to improve surveillance of trading malpractices and take timely action on them.

This is required to check price manipulation that leads to a sharp upward spiral in prices only to be followed by an equally sharp thud, inevitably crushing many small investors underneath.

Spending some resources in bolstering its surveillance department so that they can study the trading data available to catch such wrong-doers is imperative.

The NSE can also afford to come down hard on companies taking investors for a ride by not disclosing adequate information or releasing false or misleading information to exchanges.

SEBI, in its recent guidelines, has explained the ways in which exchanges should improve in this aspect.

While it would require additional manpower, improvements in this area will be favourable for the equity culture in the country in the long run.

And while we are at it, greater tolerance towards competition would also be welcome. After all, an agile competitor will help ward off complacency and keep the exchange on its toes.

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