After a long tussle with Sebi, MCX-SX looks ready to throw open its doors to companies who want to list themselves on it. The question is, do we need it?
It is more than likely that very soon, India may see the birth of a third national stock exchange that will start competing for business with the existing two, namely the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
MCX-SX, co-promoted by Jignesh Shah-led Financial Technologies (FT) as well as Multi Commodity Exchange (MCX), offers trading only in currency futures at present. The bourse is awaiting the securities market regulator’s permission to start trading in equity cash (stocks) and equity derivatives. Also anticipated is a separate trading platform for small and medium enterprises (SMEs) as well as interest rate futures, among other things. The wait may end soon.
Yet, one important question doing the rounds is whether India really needs another exchange. What will Shah’s MCX-SX bring to the table that the other two exchanges won’t?
FT group’s abilities are not in question. After all, it has an established track record in setting up and running exchanges. MCX, promoted by FT, dominates the commodities futures market in India with an over 80 per cent market share. MCX-SX is also a strong player in the currency futures segment. The average daily turnover in currency futures traded on the exchange this year is around Rs 12,090 crore, higher than the Rs 11,798 crore on its main rival NSE.(Click here for chart)
It also has international cache. The FT group has opened a slew of exchanges worldwide such as the Dubai Gold & Commodities Exchange (DGCX), Singapore Mercantile Exchange (SMX), the Global Board of Trade (GBOT), Bahrain Financial Exchange and Bourse Africa. Of these, DGCX is doing relatively well, while the others are yet to see a meaningful turnover.
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Reality check
The problem, therefore, isn’t so much with MCX-SX’s credentials as it is with the basic justifications for its existence. Here’s the problem with a potential third exchange: Unlike in a developed market like the US, where the two leading stock exchanges—NYSE Euronext and Nasdaq OMX—have very few stocks in common traded on their platforms, a majority of the stocks are listed on both the NSE as well as the BSE in India. A third exchange could lure liquidity away from the other two exchanges by offering trading in the same set of stocks, say experts. “A new stock exchange in equity per se does not necessarily and automatically create new sets of investors and issuers. Market fragmentation results in loss of liquidity for all exchanges. Following game theory then, even the efficient exchanges lose their efficiency and profitability,” said Pratip Kar, consultant and member, advisory council, global corporate governance forum, International Finance Corporation (IFC).
This is probably why many of the world’s top financial centres have only one dominant exchange. In Japan, the Tokyo Stock Exchange (TSE) accounts for 96 per cent of the total trading value. In Germany, the Frankfurt Stock Exchange accounts for over 90 per cent turnover in the German market. The US offers a slight variant to this rule where two exchanges remain dominant: NYSE Euronext has about 25 per cent market share in total equity trading, while Nasdaq OMX has about 20 per cent. Trades conducted on electronic communications networks, dark pools and over-the-counter (OTC) trading collectively have a nearly 28 per cent share of the total number of equities traded in the US.
"It's not bad to have a third stock exchange, but there is no desperate need for it. It's not that current or new investors will not be serviced well by the current service providers ,” said Avinash Gupta, head, financial advisory, Deloitte Touche Tohmatsu (India). “It essentially boils down to a realistic and rational assessment and not an emotional assessment of sustainable demand,” says IFC’s Kar. “I have not seen many people who have or wanted to set up new exchanges or run the existing exchanges take this realistic assessment of sustainable demand for an exchange or a product seriously,” he added.
Monopoly buster
Still, any market is better off without monopolies and MCX-SX can play a valuable role in thwarting them in India. For example, in December 2009, MCX-SX had dragged NSE to the Competition Commission of India (CCI) alleging predatory pricing in its currency derivatives segment through cross-subsidisation from the monopoly profit made in the equity cash and equity derivatives segments. In June 2011, CCI found NSE guilty of abusing its dominant market position and asked it to stop unfair trade practices such as subsidising services.
“While exchanges exhibit a large degree of network externality (like self-contained telephone or rail networks), natural monopolies are common and one can argue that new competition adds little value,” said Rajesh Chakrabarti, assistant professor of finance at the Indian School of Business (ISB). “On the other hand, a stock market with a virtual monopoly can indeed gain by having a competitor to keep the dominant player up-to-date with technology and customer service innovations in a fast-changing environment, a role that BSE has largely failed to accomplish,” added Chakrabarti.
While justifying MCX-SX’s position, or denying it, has equal takers, the fact remains that it has been three long years for MCX-SX to get to this juncture where it is on the cusp of tasting victory. When it originally applied for an equity exchange, Sebi rejected it. MCX-SX appealed and the case went to the Bombay High Court which dismissed most of Sebi’s arguments such as interpretation of rules regarding persons-acting-in-concert and shareholding norms. Sebi then petitioned the Supreme Court, which on April 11, asked the regulator to consider afresh MCX-SX’s application for operating as a full-fledged stock exchange within three months.
The regulator, which came out with a fresh set of shareholding norms for stock exchanges on April 2 prior to the Supreme Court’s verdict, will amend the MIMPS (manner of increasing and maintaining public shareholding in recognised stock exchanges) rules, which MCX-SX will have to comply with.
Making a difference
Once MCX-SX gets its final approval, it won’t have much time to savour its victory. Experts believe that the new exchange will have to bring innovative products, reduce transaction costs and offer superior services to investors and market intermediaries in order to make its mark in the equity trading space.
“MCX-SX may come up with new trading rules and improved trading costs and technology to compete with the NSE,” ISB’s Chakrabarti says. “While exact product advantages are difficult to foretell, there is still significant room for improvement, particularly for institutions that span multiple markets and need the flexibility to put in place complex portfolio trading strategies.”
A detailed questionnaire sent to MCX-SX’s spokesperson on the bourse’s strategy remained unanswered.
A stock exchange business requires a deep understanding of the financial market and in India as elsewhere, it has become far more mature and complicated than it was even a decade before, say experts. “It is very critical for the new exchange to be able to create meaningful differentiators in terms of newness and innovativeness of products, trading efficiency, transaction costs and incentives to the intermediaries,” says Kar. “Only then will it be able to lure away the existing investors, brokers and issuers from the existing markets to the new market.”