F&O: BSE to return to cash settlement

After testing the physical (delivery-based) settlement system in the equity derivatives segment, the Bombay Stock Exchange (BSE) has decided to return to cash-based settlement from May. Market players said the move might intensify competition between the exchanges.

In 2010, BSE had shifted to physical settlement, as part of its strategy to differentiate its product from that of the National Stock Exchange (NSE). NSE follows cash settlement for its stock futures and options trading. With average daily volumes of about Rs 1,50,000 crore, it is the market leader. Currently, BSE generates Rs 15,000-20,000 crore of average daily derivative volumes. Stock brokers say BSE’s move might boost the volumes on its platform, as foreign institutional investors (FIIs) prefer cash settlement, owing to the lower cost of trading.

Under the physical settlement process, a seller of stock futures or options has to deliver shares to a counter-party, if he so demands during derivatives expiry. This may raise the cost for traders, as they may have to borrow shares to settle delivery obligations. Later, they may close the borrowing transactions, too. In India, the statutory cost for delivery-based transactions is higher than that for the equity derivatives segment.

In his Budget 2013-14 speech, Finance Minister P Chidam-baram had cut the securities transaction tax (STT) in the equity futures segment 40 per cent. Currently, STT of Rs 2,500 is charged for delivery-based transactions on every Rs 1 crore of trade; on non-delivery trade, it is Rs 1,000. Though STT may seem to be a minor tax, it earns the state exchequer Rs 6,000-7,000 crore of revenue a year.

Statutory levies in the equity market account for 55 per cent of the total cost of trading in India. Not surprisingly, delivery-based volumes stand at 10-20 per cent of the daily average.

In the US and Europe, the cost of trading in equity, including brokerages, is about Rs 500 for trade worth Rs 1 crore; in India, it is as high as Rs 1,300, including Rs 850 (average) of STT. While Rs 200 goes to the exchange, Rs 200 is paid as stamp duty, Rs 21 is accounted for by service tax and Rs 10 is collected by the Securities and Exchange Board of India. There are brokerage charges, too. If the trade is delivery-based, it attracts depository and demat charges as well. In the options segment, the cost is higher, as stamp duty is charged on the turnover, including brokerage and other charges.

Experts say the physical settlement system is the most effective tool to curb market manipulation. When short-sellers try to artificially suppress the price of a particular scrip, the counter-party can ask for delivery. Thus, the short-seller may have to buy or borrow shares from the market, which may act as a cushion for falling share prices. Till now, traders in the BSE derivatives segment enjoyed an advantage over other exchanges — as BSE followed the physical settlement process, traders could push the delivery of shares in the derivatives segment and pay less STT, since their actual trade was a part of futures and options, for which the cost was less. However, FIIs didn’t subscribe to this idea.

BSE’s liquidity enhancement schemes have given it the much-needed attention of large FIIs which are now connecting to its platform. But the exchange has to address the issue of slow trading systems. Recently, BSE announced it would upgrade the systems to cut trading time.

The newly-launched MCX Stock Exchange follows a cash-based settlement system for its derivatives segment. However, here, volumes are yet to pick up in a big way.