MCX-SX has battled long and hard to start India’s third countrywide stock exchange. But many market participants argue that India needs a third equities platform about as much as a car needs a fifth wheel!

They believe that the NSE and the BSE, put together, already offer everything there is to offer in the business of running a bourse. With 6,000 listed companies between them, they already have one of the largest pools of listed stocks in the world. Then, they operate on the state-of-the-art automated trading systems, backed by well-oiled clearing and settlement machinery. This market infrastructure is so efficient that, despite sky-rocketing traffic and volatility, there have been hardly any instances of systemic failure or payment default on the bourses in recent history.

Three-fold objective

While all this is true, great infrastructure, efficient systems and a large universe of listed instruments alone do not make for a thriving marketplace. After all, the primary objective of any stock market is threefold. It should allow new businesses to raise capital to fund their needs. It should facilitate the allocation of capital to the most deserving through fair price discovery. And it should provide liquidity, at all times and at the right price, for investors to buy and sell their holdings.

On these points, Indian stock exchanges cannot claim to have reached the pinnacle of success. Therefore, these are the very areas in which MCX-SX can distinguish itself from the existing bourses.

Challenge #1: Focus on the cash market

Though the NSE and the BSE do a combined business of over Rs 2 lakh crore on any given trading day, over 95 per cent of that daily turnover comes from derivative products. The cash market, where genuine investors buy or sell businesses for their long-term prospects, accounts for a mere 5 per cent of traded volumes. These cash volumes have been steadily dwindling. Between 2009-10 and now, the cash turnover on the exchanges has plunged by nearly 40 per cent.

Despite an expanding universe of stocks, liquidity in the cash market seems to be on a downtrend, too. Ten years ago, about 0.3 per cent of the market cap on the NSE used to change hands on any given day, but now the proportion is 0.15 per cent. Market depth too is suspect, with liquidity restricted to the top 200 stocks. The shrinking cash market is a concern for Indian companies, as this is the only segment of the market in which they can raise capital to fund their expansion or working capital needs.

Now, it may be quite tempting for a new entrant such as MCX-SX to build volumes by launching newer derivative contracts, with hefty incentives. But focusing on a robust cash market may be a better way to build a real stock exchange.

Challenge #2: Widen product menu and investor base

But how can a Johnny-come-lately revive the cash market for stocks?

Well, getting long-term investors interested once again in buying shares is not an easy task. But it can be accomplished through better reach and product innovation.

When the NSE first burst upon the Indian stock market scene in the nineties, it managed to steal the thunder from the entrenched BSE mainly by making equity markets accessible to all. Its electronic platform made sure that access to equities was not confined to a cosy club of brokers in Mumbai.

Today, with retail participation at a low ebb and FIIs dominating the market, the situation is quite similar. MCX, with its experience at building a market for new categories of commodities, may have two advantages — better access to Tier II and Tier III cities, where the equity cult can be spread and equities can be promoted to a captive base of commodity investors.

Product innovation is also a live possibility. Neglected product categories such as debentures and bonds can be revived to attract retail interest. Exchange traded funds (ETFs) tracking new markets (such as the Hang Seng), new asset classes such as silver and real estate, offer promise too. The interest of investors may be spurred by new benchmarks, which track a wider basket of stocks like the Sensex or Nifty or a specialised class of stocks like, say, commodities.

Challenge #3: Raise the bar on regulation

A third factor on which a stock exchange can differentiate itself is by setting a high bar on the quality of companies and members who do business on it.

One aspect of this is surveillance and regulation of trading activity. If manipulation by a coterie of brokers was a key challenge to market integrity in the days of ring trading, it is the tech-savvy algorithmic and high frequency traders who pose such a risk in today’s markets. High frequency trades account for 25-30 per cent of trading volumes on the Indian bourses today. Instances such as wild swings on Muhurat-day contract values on the BSE and freak quotes on futures contracts on the NSE, show that monitoring these trades and putting in place checks and balances against them is no easy task.

MCX-SX with its strong technological backing may be well placed to design surveillance systems that match the capabilities of algo traders.

In fact, raising the bar on surveillance could help curb other instances of market manipulation, too. The many instances of blatant price-rigging in IPOs, uncovered by the Securities and Exchange Board of India (SEBI) just last year, show that, despite electronic trading, Indian markets aren’t immune to price manipulation.

Challenge #4: Be more transparent

A final value-add that investors, market participants and policy makers would readily welcome from the new bourse would be easier access to information, whether it is about companies or about market action.

The stock exchanges have access to a treasure-trove of information on the financials, shareholding and material corporate action that companies are mandatorily required to file with them. But access to this information is made quite difficult for investors, due to lack of a user-friendly interface on the Web sites of the existing bourses. Organising this information and presenting it in an easily accessible fashion can, in fact, make the exchange Web site a one-stop-shop for any fundamental investor.

More disclosures on market action, broken down into participants, securities and intermediaries, would always be welcome. But after all the attention that MCX-SX’s ownership structure has attracted in its skirmishes with the regulator, one periodic disclosure that the exchange must make is the volume of its business broken down into key trading members.

This is one disclosure that will establish the new exchange’s credentials with investors, better than any other measure can.

Great infrastructure, efficient systems and a large universe of listed instruments alone do not make for a thriving marketplace. There are other areas in which MCX-SX can score over the existing bourses.

(This article was published in the Business Line print edition dated July 30, 2012)
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