The Indian financial markets will undergo a tectonic shift after being a comfortable quasi-monopoly for many years. For over a decade, the National Stock Exchange (NSE) held overwhelming market share in cash equity transactions and in equity derivatives. The Bombay Stock Exchange (BSE) was a distant second and the regional stock exchanges nowhere. This is set to change. The regulator has allowed the MCX Stock Exchange (MCX-SX) to offer equity and equity derivatives contracts. The BSE is displaying new-found aggression. The Delhi Stock Exchange (DSE) has been recapitalised, with the London Stock Exchange taking a five per cent stake, and it has ambitions of going national.
Competition is good. But will not four exchanges offering almost exactly the same basket of contracts crowd the market? While it should bring more efficiency to an already-efficient trading process, it will also spark a price war in brokerage. All the competing exchanges will try to attract high-volume algorithmic traders. There will be a temptation to shave margin requirements, and to construct new, potentially risky contracts and perhaps, to cut corners or manipulate settlements. It will be incumbent on Sebi to tighten oversight. The regulator has hiked the eligibility norms for trading in the futures & options (F&O) segment, dropping 51 stocks from the F&O list. It will also have to review risk management matrices and to evaluate new contracts and margin changes with care to exclude the chance of black swan defaults.
Competition is already heating up. In May 2012, the NSE held 80 per cent of volume in cash transactions, with the BSE holding about 19 per cent. The NSE also generated almost 100 per cent of F&O volume. In June, the BSE started catching up. In the last fortnight, the BSE matched the NSE in F&O volumes and overtook it in the options segment. This has come at a cost and perhaps, at an increased risk. Apart from lower brokerage charges, the BSE has paid over Rs 60 crore in incentives to brokers to be F&O market-makers in a “liquidity enhancement scheme”. Market making means writing options with theoretically unlimited risks. Spread arbitrage can get complex; the BSE also plans to offer new F&O contracts on the BSE-100 Index and to create a new class of derivatives, arbitraging the carrying cost between equity and futures prices. MCX-SX already matches the NSE in currency futures. It is well-capitalised after the initial public offer. MCX-SX will certainly hit the ground running with a combination of incentives.
India’s market capitalisation to GDP ratio has fluctuated from 55 per cent during bear markets to above 160 per cent during bull runs with far higher volumes in bull markets. It’s unclear what sort of ratios and daily churn is sustainable. The BSE and NSE log over Rs 2.5 lakh crore in daily transactions at the moment, with market capitalisation at around 65 per cent of GDP. Volumes will almost certainly increase. If the F&O market overheats as a result, there could be problems. If exchanges over-extend, or defaults are triggered by mishandling new and complex contracts, there could also be blow-ups. Sebi has a tough job ahead.
| Clarifications |
| The editorial contains certain mix-ups in its references to MCX-SX and MCX. MCX Stock Exchange, known as MCX-SX for short, and Multi Commodity Exchange of India (MCX) are two separate legal entities, operating under separate regulators. MCX is the world’s second-largest commodity exchange and is regulated by the commodity markets regulator Forward Markets Commission (FMC). MCX-SX is a stock exchange operating under Sebi’s purview. MCX, one of the initial promoters of MCX-SX, now holds only five per cent in the stock exchange with the rest of the shares being held by banks and domestic financial institutions. It is MCX that is listed, not MCX-SX. In fact, MCX is the first listed exchange in India. The IPO or state of capital of MCX has no relation to or bearing on MCX-SX’s plans. |
Setu Shah
Senior VP – Communications,
MCX Stock Exchange Ltd, Mumbai