Should brokers be kept out ot the debt mart?

ISSUE

Exclusion unfair

MAHDUR MURARKA
Director
Mata Securities India

After the incineration of the debt secondary markets during the 1992 scam, we were all agog when the NSE was created as the harbinger of modern technology in our securities markets. After a faltering start, NSE's annual trading volume in debt zoomed to more than Rs 13,00,000 crores last year.

But somewhere along the way, something had gone seriously awry. None of those trades were being executed on the exchange's platform! Orders to buy and sell, mostly from financial institutions, were being individually matched by the brokers ("telephone market") and merely reported to the exchange. Just like the good old days.

Brokers faced biting criticism from regulators, academia, and even from the senior management of the exchange, who imagined a devious plot by brokers to derail market evolution, and the formation of a closed club for perpetuating their monopoly over the debt markets.

The truth is that though debt brokers could stare at red and blue blinking lights on their screen, the real machinery behind the screens was never provided. When you buy or sell on the equity screen, your counterparty is the clearing corporation called NSCCL, and thus, you do not have to bother who is the ultimate seller or buyer.

In the debt markets, such a clearing corporation was missing. Though you were expected to trade with unknown parties (anonymous trading), there was no one to guarantee the trades.

Clients, especially institutional, cannot trade with ghosts. To fill this need, the RBI set up the Clearing Corporation of India (CCIL), but the CCIL does not provide this facility to the NSE debt platform.

The telephone market has worked well. It accounts for 70 per cent of all debt trades in the country. And, notwithstanding all charges of inefficiency and opacity, the brokers who operate this market are able to quote prices with 2-3 paise spread with immediate execution (viz. better than international standards).

Brokers in this market have provided their services at wafer-thin brokerages. Were it not for the onerous service tax and stamp duties, the normal brokerage of 0.5 basis points (against 25 to 50 basis points in the equity markets) could have been further reduced to 0.2 basis points.

If there is any entry barrier to this business (besides demand-supply economics), it is the Securities and Exchange Board of India turnover fee which would make this business completely unviable in the first five years of a brokers' operation.

Brokers are not tied in to the telephone markets. Sure, when regulations permit, and with proper settlement infrastructure, brokers would not only trade on electronic platforms, but would also create such platforms themselves.

The arguments for or against brokers may not be relevant at all. To maintain sanity and order, the law of the country requires that securities transactions take place through entities that operate under the securities exchange laws, just as you would audit your books not by anyone but chartered accountants, or go to a registered medical practitioner for medical advice. It is mandatory, not a choice.

Intermediaries are important

JAYESH MEHTA
EVP & Head-Debt Markets
DSP Merrill Lynch

I would say that market intermediaries are an important part of every market and in this instance I present my case highlighting the importance of brokers in the Indian fixed income market.

Intermediaries play an important role in most asset markets. Apart from bringing the buyers and sellers together in an efficient manner and helping in price discovery, they also fulfill other important needs.

They provide information on the market developments and in some cases an additional researched or informed view on the asset that helps the investors in making informed decisions.

The widespread dissemination of information in markets increases order flows which in turn increases the liquidity, especially in largely institutional markets, makes it very important to have brokers so as to improve the price discovery process.

The motivation for transactions among market participants could be varied. Demand/supply can be generated internally on account of principal requirement or out of structured products that a firm has invested in or is selling, customer flows brought by the sales group and finally external investors brought by brokers who complement the internal sales team.

World over fixed income professionals are serviced by the brokers and end-investors are serviced by the sales teams of big trading houses. Brokers are largely instrumental in the price discovery of plain vanilla products.

Even on electronic exchanges, in the case of equity markets, brokers provide a research market feed in addition to proprietary research and brokers help in price guidance. E.g. FIIs and MFs would otherwise have their own trading terminals.

By putting the market into a closed user group of end investors will impact liquidity adversely.

Unlike in the case of equity markets where liquidity requirements vary, players in the debt markets also invest on account of cash management requirements and market liquidity is a key consideration for their investment decision. If liquidity is compromised, there could be adverse repercussions on the market.

One can also look on screen based verses voice broking, world over and also in India screen based broking/ trading in equities have been successful, but the same is not true for debt.

The reason for the same is as Debt securities are homogeneous unlike equity i.e. typically the interest rate change have a change in yield curve which impacts all debt securities unlike equities where individual securities does not move in the same direction. b) Typically the buyer /seller takes a view on yield curve so he maybe indifferent to buy or sell the securities of the same segment of the curve, unlike equities where buyer/seller takes a view on the company. c) In some of the markets there are screen based trading provided by brokers.

The concept of the introduction of an electronic exchange without brokers for the trading of debt securities may work well for benchmark security. However, the new system should be allowed to operate along with the existing system. Over time, depending on the efficiency of each system, the market will shift to one system or both systems would co-exist.

The views expressed by the author are his own and DSP Merrill Lynch Ltd may not subscribe to the views, in full or in part.