How NSE made shares less risky

Think the stock market is a minefield? Well, you probably weren’t trading in it 20 years ago. Can you imagine paying in advance for your shares and waiting with bated breath for a month to receive them?

Or signing a truckload of transfer deeds to get shares registered in your name? Or never knowing the current price of the stock and always buying it at the day’s high?

Well, this is how stock trading used to be before the National Stock Exchange (NSE) burst upon the scene in 1993. As the exchange celebrates its twentieth anniversary this week, we talked to a number of old-timers in the markets to find out what has changed for them.

Believe us, not one of them was nostalgic about ‘the good old days’.

Accessible to all NSE’s biggest contribution to the market was the democracy it ushered into stock trading. By linking up trading centres across the country through V-SAT terminals, it made sure that a small investor sitting in Ranchi had the same opportunity to trade as the fat-cat at Fort, Mumbai.

Electronic trading replaced the system of ring trading prevalent on the BSE, where only a select coterie of brokers, through open outcry, could trade on the exchange floor. Costs were sky-high too, with a BSE membership card costing over a crore and brokerage fees at 1-2 per cent of the transaction value. Contrast that with the 10 paise brokerage deals you get today!

On the BSE, investors wanting to buy or sell a stock had no ticker tape to rely on. They went by ‘quotes’ provided by the broker, who in turn had to rely on his man in the trading ring to call and give him the latest quote.

Recollects Subodh Modi, 55, an avid investor from Mumbai since the late seventies, “It used to be a tamasha . You had to call the broker a day in advance and tell him the price you want. The next day he would go to the exchange and see what other brokers had to offer. As there was no mobile connectivity then, he would take a call on your behalf and close the deal. So, you never knew if he got the best price for you.”

Another long-time trader is more candid. “Brokers usually gypped clients. If you placed an order for 10,000 shares, the broker would front-run it with 1,000 shares of his own and your shares would be always bought at the day’s high!” he remembers.

Transparent quotes NSE’s system of screen-based trading with an electronic order matching system changed all this. Says Anoop Bhaskar, Group President and Head of Equity at UTI Mutual Fund, “NSE’s biggest contribution was transparency — one nation-wide order book that everyone could see, from the small investor to the big institution.”

When the order book became public, poof went the advantage that the big guys had over ordinary folk. Orders were matched on price-time priority by the computer; the first trader to punch in his order got the best price. Today, says Bhaskar, traders can even ask the exchange for a volume-weighted average price (VWAP) to check exactly how much the trade price deviated from the day’s trends.

The electronic order book dislodged many jobbers from the market too, reducing price differentials between exchanges, points out Nagappan Valliappan who heads an investor protection forum in Tamil Nadu and has been in the market for two decades.

“Earlier, the same share used to trade at very different rates across regional exchanges. Brokers pocketed the difference and hardly anything came to investors, as they were clueless about what happens on the exchange floor. But once NSE came in and trades went electronic, there was a single order book for the whole country and a single price for every stock”.

Smooth settlements If small investors had a difficult time placing an order, that was just the beginning of their troubles. After paying in full for the shares, sometimes you would still not receive them because of bad delivery or the other guy reneging on his trades!

Ajay Menon, Chief Operating Officer, Motilal Oswal Securities, recalls, “The biggest change that NSE ushered into the markets was a good settlement system. Earlier, one had to cope with bad deliveries, defaults and all sorts of problems.”

Vijay Saamat, a big-time stock trader in the early 1990s who now runs a chocolate factory at Mumbai, says, “Settlement used to take 10-12 days; the shares would reach us only through brokers. When I was a sub-broker, I saw cases of fake share certificates too.”

Bhaskar remembers how transacting in shares after events such as dividends or mergers used to be a nightmare with ‘book closure’ stretching on for weeks at times, as companies tallied their record of shareholders.

Then, there was the problem of bad deliveries. Institutions which traded in lakhs of shares used to receive hundreds of transfer deeds.

They had to be signed and the signature had to tally with that in the company’s books for the trade to be settled.

If signatures on a single certificate didn’t match, the trade was invalidated.

Dematerialisation of shares was the answer to this. The Depositories Act was enacted by the government in 1996 and NSE, IDBI and UTI jointly set up the NSDL — an entity that held and transferred shares in electronic form. This did away with the problems of physical certificates.

No defaults But the one problem that remained was counter-party risk.

Remembering his early days in the market, Leopaul George, who started his career in 1992 with a regional stock exchange and now heads an investment company, says “Then there was always the fear of not receiving shares against payments for stocks, this deterred many from investing large sums in the market. I have seen many people lose big money in the Calcutta Stock Exchange payment crisis.”

Observing that demat alone wasn’t doing the job, the NSE set up the National Securities Clearing Corporation Ltd (NSCCL) in April 1996, to act as a counter-party to each trade.

NSCCL was given the responsibility of guaranteeing full financial settlement and maintained the exchange’s settlement guarantee fund.

The recent National Spot Exchange crisis tells us just how easily counter-party risk can bring down an exchange.

Surveillance system By putting up an electronic order matching system, the NSE had ensured faster price discovery than ever before, but there was still a high incidence of circular trading and manipulation.

This created the need for a surveillance mechanism — a system that could monitor open positions of members constantly. The NSE built a strong technology-based surveillance system for its capital market segment as early as 1998, to detect aberrant trades and take action against the member.

Risk containment measures such as capital adequacy requirements for members, margin requirements for clients and immediate disablement of member log-in if certain limits were breached, were first-of-their-kind in India in the 1990s.

Yes, after this long story, we can hear your dissent. ‘But are you saying the Indian stock market is safe for the retail investor? Look at the wild swings in the indices, insider trading, volumes shifting to derivatives….what is the NSE doing about all of that?’

Well, India’s largest stock exchange and its stock market regulator SEBI are both only 20 years old.

Give them time and they may yet deliver on their original promise to the small investor.

> aarati.k@thehindu.co.in

> rajalakshmi.sivam@thehindu.co.in

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