BSE: No quick-fix solutions

The first image that springs to mind when we think of India stock market is Jeejeebhoy Towers that houses the Bombay Stock Exchange (BSE). But BSE's market share has eroded sharply in the last decade and it currently finds itself a distant second to the National Stock Exchange (NSE).

History

How did this come to pass? Only three exchanges existed prior to India's Independence: The Bombay Stock Exchange, the Calcutta Stock Exchange and the Ahmedabad Stock Exchange. Twenty other regional stock exchanges were set up subsequently to cater to the investors and companies in the respective zones. The Bombay Stock Exchange was, thus, initially stipulated to cater to only investors in and around Bombay.

It is this legacy that tied it down after November 1994, when the National Stock Exchange was launched as an online pan-India exchange and began expanding its reach rapidly.

Though BSE shifted to on-line trading in May 1995, the government did not give it permission to expand nation-wide until 1997. The delay of two years has proved to be the destiny-changer for the BSE, as the NSE forged ahead in this period to become the largest stock exchange in the country.

Derivative trading was launched by both the exchanges simultaneously in 2000 and the NSE cornered a lion's share ostensibly because traders preferred this exchange, as it offered greater liquidity, lower spreads and better price discovery. However, report published by Competition Commission of India (CCI) late last year suggests that NSE's waiver on transaction charges on derivative trades in 2000 and 2001, also helped it garner a greater share from BSE, that was going neck-to-neck in the early stages.

Declining market share

BSE enjoys 23 per cent market share in the capital market (CM) segment. Although its share is down from over 40 per cent before 2000, the exchange can take heart from the fact that this share has been held over the last two years.

It is the derivative turnover that is a cause for concern since volumes in this segment are abysmal on the BSE, with the NSE dominating here with almost 100 per cent share.

Given that daily derivative volume on the NSE is 10 times more than that in the CM segment and this segment has grown 800 per cent in the last five years, the BSE needs to act fast to improve volumes here. The capital market segment, on the other hand, has only doubled from around Rs 10,000 crore to Rs 20,000 crore in this period.

Future in jeopardy?

Pessimists may take the BSE's dwindling market share as a sign that the exchange may be on its way out. That is unlikely due to various reasons.

The BSE has almost twice the number of companies listed on it when compared to the NSE; 5,000 companies and nearly 7,800 scrips. While this does throw up issues of trading malpractices since many of these are small-cap companies, this is one of the prime features that ensures the survival of the exchange.

Brokers cannot afford to not have membership of the BSE lest their clients wished to trade in such stocks.

The other factor conducive for the survival of the BSE is the presence of arbitrageurs who play on the difference in spot rates between the two exchanges. It is these trades that the exchange is trying to increase through Smart Order Routing (SOR) and making provision for co-locating facilities in BSE premises for faster execution of orders. That the regulator is happier with two large exchanges offering equity trading so that investors benefit by the healthy competition is also favourable to the BSE.

Strong balance-sheet of the BSE with healthy reserves will also stand it in good stead even if its main revenue stream dries up. The income generated from trading in FY-2010 was Rs 134 crore while it earned Rs 245 crore from its investments in mutual funds, fixed deposits and so on.

Winds of change

The BSE has discarded its image as an exclusive club of few brokers with its demutualisation in 2005. This has brought in a professional board at the helm that includes Mr Keki Mistry and Mr C. Ramadorai. Among the most important move was to reduce membership deposit and fee to Rs 10 lakh from Rs 1 crore. Though this move might not have an immediate effect, it could influence the decision of brokers wishing to register with a pan-Indian stock exchange in future, resulting in greater number of trading members on the BSE in the long-term. Launching of mobile-based trading and introduction of smart order routing are other means through which the BSE hopes to increase trading volume.

To boost derivative volumes, contracts were shifted to mid-month expiry and transactions costs were also reduced in 2009. Neither of the moves had the desired effect. It is to be seen if the physical settlement of single stock futures and options introduced this year does the trick.

Road ahead

Despite the efforts made by the BSE over the last two years, volumes have not improved. That the competitor, the NSE, is extremely vigilant and quick to react to every small move made by the BSE makes the task onerous.

But a quick way to enhance liquidity and expand geographical reach would be to enter into an agreement with the regional stock exchanges along the lines suggested by the SEBI report published in 2006 ( http://www.sebi.gov.in/commreport/repcomm.pdf ). Getting all the members of regional stock exchanges to trade on the BSE would solve the liquidity issue once and for all. However, the BSE needs to adopts a more conciliating attitude by tempering the clauses unacceptable to the RSEs and can, perhaps, work out a profit-sharing (split transaction cost) arrangement.

The Sensex is the most valuable brand owned by the BSE.

The fact that all action in the BSE derivative segment is centred around Sensex futures and options reflects the latent potential. It also needs to be noted that over 70 per cent of derivative volumes on the NSE are through futures and options on the Nifty. The problem is again liquidity. How about waiving transaction costs on these contracts for six months to a year? Can't miss what you don't have isn't it?

Way forward for most exchanges, globally, has been to merge and consolidate to tap synergies. The cap imposed on ownership of exchanges by regulator closes this route in near future. The BSE can, however, use Deutche-Borse for cross-listing products. Introducing exclusive products such as the BSE TASIS Shariah Index 50 or the derivative products based on ISE indices should also help.

COMMENT NOW